Financial Tips | Debt Management

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Should you Pay off your Debt or Invest?

Many financial gurus advise that you should always pay off your debt first. In my opinion, whether or not you should pay off your debt first comes down to the interest rate you are paying on your debt versus the interest rate you could collect (or the return you could get) by investing.

Debt comes in many different forms. Many people have credit card debt, student loans, a mortgage, and some kind of auto loan. Many financial gurus state that you should pay half of your monthly mortgage payment every two weeks. By the end of the year, you will have made an additional monthly mortgage payment. This extra monthly payment will help you pay off our mortgage faster. Unless you plan on living in your home for the next 30+ years I do not like this plan. A mortgage is a fixed payment. Additionally, if your monthly payment is too high you can refinance your loan (if your credit is good). Also, many people do not live in a home long enough for the mortgage interest rate to take a toll on their finances. Also, most homes appreciate in value at a rate higher than the interest rate on the mortgage. Last, mortgage interest is tax deductible. Therefore, paying off a mortgage is not something I would take into account when deciding whether to pay off debt versus investing.

The main inquiry should be whether you should pay off your credit card debt before investing. Credit card debt usually carries an interest rate of anywhere between 8-30+%. If you have a credit card with an interest rate of 8%, you are in the minority. 8% is a very low credit card interest rate, therefore, it is more likely that you possess a credit card that has 10% or higher interest rate. Meanwhile, I am unaware of any risk-free investment that yields a 10% return. Therefore, in this case, you should pay off your credit card debt first.

If, however, you find an investment that yields a return higher than your credit card interest rate, than the investment looks like a good choice. However, you must take into account the risk involved in the investment. The stock market goes through many changes. You definitely do not want to pay your full credit card interest rate and at the same time lose a percentage of your investment.

Always carefully analyze the investment situation before you choose to invest in lieu of paying off your credit card debt. In most cases, it will be better and more profitable to pay off your debt before you invest. However, do your homework and there may be an exception that you discover.

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