Pay Off Debt: Best Investment
Do you want a surefire return? Then whittle down what you owe, whether it’s mortgage, automobile, boat, credit cards or college debt.
By paying down your debt, you guarantee a rate of return equal to the interest rate you pay on the debt. For some debt, it’s a better return than the stock market might bring. Even if you have good credit, it’s hard to come by an annual percentage rate of less than 15%, but a 15% annual gain in almost any investment is exceptionally good.
Bankrate has a handy minimum payment calculator that shows just how pernicious credit card debt is. Many cards are now showing this in the fine print on their statements. For example, I put into the calculator a $10,000 balance at 15% interest and a minimum payment of $225. After just under 28 years of paying the minimum, I paid a total of $21,980.
Pay off the card right away with $10,000, and right off the bat, you save nearly $12,000. If only it was so easy to find such a great rate of return on any other investment. So before you start sinking money into retirement accounts, a good idea is to get out of debt first.
Start on the debt with the highest interest rate. Typically, credit cards have the highest rates. Once you pay down that debt, move on to the next highest interest rate and so on.
Some people prefer to start on the smallest amount of debt first and go on from there. This strategy lets you build momentum by getting at least something paid off quickly. Then, you have one fewer account to pay the minimum on, and more money each month to pay off the most costly debt. You save more money paying down higher debt first, but if knocking down your smaller balances first gives you a feeling of accomplishment, that works just fine.
If you are struggling to find the money to get out of debt, you can get rid of luxury items you don’t need, like cable TV or dining out, until your debt is gone. Try upping your payments in baby steps until you reach zero. You can tack on an additional 10% or more on what you currently pay and increase that percentage periodically until you can pay it off in full.
One debt that you should only pay the regular monthly minimums on is your mortgage. Nothing wrong with paying it down early if you can, but with today’s interest rates at historic lows, it’s not as big of a deal as credit card debt. For example, if you just got a 30-year fixed mortgage at a 4% fixed rate, paying it off early is the equivalent of getting a 4% gain from an investment. Over 30 years, there’s a high likelihood that rates of return you can get in the market can more than offset the extra mortgage interest, unlike the case with 15% credit cards.
Of course, stock market gains are definitely not guaranteed, but in the past 30 years, including several major financial shocks and three recessions, the Standard & Poor’s 500 index grew by 1953%, assuming all dividends are reinvested. That’s an annualized return of 10.6%.
Another advantage to taking your time on mortgage payments is the ability to deduct the interest on your mortgage. You can’t do that with consumer debt.
Once you pay off all of your debt, act as though you still have to make the payment, only but to yourself rather than a lender. Continue to behave as if the bill exists, but direct it to your savings, retirement accounts, college fund or other financial goal.
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Sterling Raskie, MSFS, CFP, is an independent, fee-only financial planner at Blankenship Financial Planning in New Berlin, IL. He is an adjunct professor teaching courses in math, finance, insurance and investments. His blog is Getting Your Financial Ducks in a Row, where he writes regularly about investments, retirement savings and financial planning.
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