Scenario # 2: When Consumers Should Pay Off Debt As A Priority
According to a recent report, the average APR of the credit card is 20%. When you carry a balance with a high APR, it is important to pay it off as soon as possible. Or at least refinance with a lower-interest loan, a line of credit or a balance transfer. A debt consolidation loan can also be an option. By holding high-interest debt, you are likely to increase the time it takes to retire while negatively impacting your net worth.
Worse, if you make the minimum payments and invest the rest of the time, just keep in mind that your credit card balance can keep growing and it can take 10, 15+ years to pay off. And it doesn’t matter how much you owe! $ 100, $ 1,000, or $ 10,000. If you only make the minimum payment, the bank will win because of the potentially $ 1000 in interest dollars you give it.
Other high-yield debt
Credit cards aren’t the only high-yield debt you could bear. Other loans that might have high interest rates are payday loans, lines of credit, and other personal loans that might have high interest rates. Whenever you have one of these loans, you should always prioritize saving for retirement.
Debt Snowball Method
When it comes to paying off debt, I find the debt snowball method works well. It allows you to focus your efforts by paying off the smallest debts first while receiving minimum payments on the others. After you have paid the first debt, you can move on to the next smaller debt. Repeat this until you are debt free, or at least free of high interest debt.
There is seldom a good reason to keep depositing into an emergency fund when you have high-interest debt. Pay it off first, then focus on funding an emergency fund after. Some may disagree, but in most cases and as a last resort, consumers can re-advance borrowed funds in an emergency. Once the high yield debt is paid off in full, this is a good time to start thinking about it Creation of an emergency fund and invest in your retirement.
Low Interest Debt
Once the high-interest debt is reduced, you will need to pay off either low-interest debt such as student loans, car loans, or your mortgage. Mathematically, it often makes more sense to put the money in than to pay off low-interest debt. However, it is not a guarantee. Regardless of the debt, high or low interest rates, there is also an associated payment. This payment eats up your monthly surplus of income. So the faster the debt is paid off, the more money you can use for investments.
Financial advisor option
Hiring a financial advisor is almost always a good choice. Consultants often give you a point of view that you may not have considered. They are also experts in personal finance and already know about everything that is written here.
Scenario 3: Balance between retirement provision and debt repayment
Can you have your cake and eat it too? Maybe! In some cases, it can make sense to pay off debts and save for retirement at the same time. It will certainly take longer to pay off all of your debts. However, if the debt has a low interest rate and is associated with a manageable payment (i.e. a mortgage), yes, it makes sense.
Also, if you have excellent credit, you might be able to do one Lower interest rate on your mortgage through demand or refinancing. With 30 year interest rates below 3%, the money is practically free. By refinancing AND extending your amortization to 30 years, you create monthly income in your budget so that you can invest more.
Mortgage Tip: Plan to repay your mortgage in full just before retirement. This way, not only can you sleep better at night, but it also unlocks a large payment that will eat up your retirement budget.
Final thoughts on debt and retirement planning
Ultimately, the decision depends on the amount of interest you pay on your debt.
Before deciding which strategy to choose, you should consider the psychological implications of being debt or mortgage free. For some, living mortgage-free is important because they think the house is “owned by the bank”. Or maybe the thought could be, “What if I lose my job”. In any case, it depends on your comfort.
It’s worth noting that borrowers can sometimes get certain tax breaks when paying certain types of debt. For example, in some situations interest on mortgages or investments can be tax deductible. Tax deductions could result in a higher tax refund at the end of the year. But as always, always consult a qualified financial professional for the best advice!