Understanding the advantages and disadvantages of paying off debt is crucial to your strategy.
Reduced stress and anxiety: According to FP Canada’s 2023 Financial Stress Index, nearly half (48%) of Canadians have lost sleep over finances, and one in three (36%) have experienced money-related mental health challenges. Constantly worrying
about debt can take a toll on mental and emotional well-being. By paying off debt, you can experience relief and reduced stress, leading to improved overall happiness and peace of mind.
Interest savings: When dealing with debt, it's essential to be aware of accumulating interest charges, particularly in cases involving credit cards or loans with high interest rates. The Financial Consumer Agency of Canada (FCAC) provides
a credit card payment calculator designed to help you assess the outcomes of three distinct approaches related to your balance. These
approaches include exclusively paying the minimum monthly amount, combining the minimum payment with additional contributions, and consistently sticking to a fixed monthly payment.
If you only pay the minimum amount, you won't make much progress in lowering the original sum of money you borrowed or owe (the principal amount), and you'll end up paying a lot more interest over time. But if you pay more than the minimum or stick to
a fixed monthly payment, you can reduce the principal amount faster and significantly reduce the interest accrued throughout the debt's lifespan, accelerating your path to becoming debt-free.
For instance, imagine you have a $1,000 balance with an interest rate of 11.69%. If you pay only the minimum payment — $30 per month — it will take 3 years and 5 months to pay off the debt and cost you an additional $157.69 in
interest. However, if you increase your monthly payment by just $5 above the minimum requirement, you could eliminate your credit card balance 7 months earlier, resulting in interest savings of $37.36. Alternatively, if you consistently pay $100 each
month instead of the minimum, you could potentially pay off your debt 2 years and 6 months ahead of schedule.
Lower monthly debt payments: When you have less debt, you are required to make smaller monthly payments towards your outstanding balances.This reduction in debt-related expenses leaves you with more disposable income each month.
Ability to invest: Paying off debt opens up opportunities for investing. Instead of channeling money into high-interest debt, you can redirect those funds into investment vehicles that can grow your wealth over time, such as stocks, bonds,
or Guaranteed Investment Certificates (GICs).
Credit score impact: Paying off debts on time can improve your credit score leading
to better financial opportunities in the future, such as lower interest rates on loans and higher chances of approval for mortgages. However, when you pay off all your debts you may see a decrease in your credit score. It's temporary but that’s
something to keep in mind.
While paying off debt is generally considered a positive financial goal, there can be some tradeoffs to consider, depending on your specific circumstances and financial goals.
Prepayment penalties: If you pay off some types of debt early, like mortgage debt, you could incur additional fees or penalties, negating some of the financial benefits of early repayment.
Opportunity cost: While
you're diverting all your extra funds toward debt repayment, you might miss out on investment opportunities that could provide you with significant returns in the long run. If the interest rate on your debt is lower than the expected return on your investments,
you might miss out on potential gains.