Paying off debt is a popular financial goal because so many find themselves swamped by loans of all different types. Most young adults have a combination of student loans from college, credit card balances outstanding, department store card balances, car loans and possibly even a mortgage. With such a long list of ways to rack up debt it’s no wonder that people are frantically trying to get out of the red.
The following are a few solid reasons why debt reduction is a good idea.
Paying Off a Loan Improves Your Personal Debt Ratio
The debt to income ratio is a financial calculation that is used as a way of measuring an individual’s ability to repay outstanding loans. Total debt, which may consist of housing and other loans, is divided by gross income to give a percentage.
This is the equation that is used by mortgage lenders to calculate a loan applicant’s capability of repaying the loan. For the purpose of granting a mortgage loan however all other debts are usually excluded from the calculation and lenders normally feel comfortable allowing housing costs to use up to 28% of gross income. Getting rid of other loans before putting in a mortgage application is therefore a good idea.
Getting Rid of High Interest Loans Can Improve Your Financial Fitness
Generally speaking, paying off high interest loans helps to quicken the pace with which loans are repaid. This is the philosophy used by the debt snowball (paying off high interest debt first before moving to lower interest categories). Repaying loans means that more money can be channeled into savings and investment instead of paying interest on debt.
Paying Off Debt May Be Better Than Saving
In times of low interest on savings and little or no investment opportunities it is wise to put excess money into a plan for debt reduction. The money will be used to get rid of negative interest which erodes personal net worth. To some, putting all extra money into debt reduction can feel counterproductive but the faster debt can be wiped off the sooner your money can get back to earning a full rate of return because there will be no opportunity cost of using the money to repay outstanding loans.
Cutting Down Your List of Creditors Creates a Feeling of Satisfaction
Finally, paying off debts simply feels great. Few pleasures rival the knowledge the outstanding balance on the mortgage is slowly being chipped away. This speaks straight to a feeling of financial security and well-being that is extremely important to overall personal money management plans.