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What Is A Paydown?

A paydown refers to reducing the overall debt owed by an individual, company, or government.

Deeper Definition 

An individual or organization makes a paydown by paying off a significant portion of the principal on loan. Paying down the principal on loan reduces the amount paid as interest.

Paydown applies only to efforts made to reduce the original amount received as a loan. For instance, payment on an interest-only mortgage does not count as a paydown because it reduces the principal amount. The goal is to shrink the principal, and by doing that, less interest will accrue on loans in the future.

Paydown involves paying more than the minimum required payment on a loan, and it prioritizes paying off debt over saving. Often, borrowers with a limited budget are unable to decide whether to pay off debt or save. Below are the advantages of paying for debts faster:

  • It reduces the amount of interest paid over time, particularly helpful if it is a high-interest debt.
  • By paying debt off fast, a borrower will soon be able to focus entirely on saving and other financial goals.
  • It can help improve your credit score, which would allow you to take more loans in the future.

A borrower with a limited budget may choose to prioritize savings instead of making a paydown on debt. Their reasons for doing that include but are not limited to:

  • To take advantage of compounding interest accrued on savings.
  • They have a goal they are working towards, and a paydown would disrupt their timeline for achieving it. 
  • They want to avoid incurring a new debt if an unexpected expense arises.

Paydown Example

Alice takes a credit card loan of $5,000 with 17% interest. The minimum repayment rate is 4% monthly. If Alice decides to make only the minimum payments, she will spend years servicing the loan while the interest keeps growing. For Alice to avoid paying the excess amount of interest, she would make the minimum payments plus extra to reduce the debt faster.

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