Weighing the Options: Pay off Debt or Invest?

It’s the age old question – Would it be better to pay off my loan or invest for the future?

Below we take a closer look at a few types of loans.

Mindy Fetterman, USA Today, in her article Pay off debt or invest?  That is the Question, outlines the purely rate of return argument.  She asks, “If you pay 16% interest on a credit card, could you earn 16% safely and consistently on an investment?”  If you can’t, then the reasonable answer would be to pay off the debt.  She does mention that not all debt is the same and some can be considered, “good debt.”  Examples of good debt could be low-interest student loan, mortgage or margin interest on a brokerage account.  These are considered good debts because the interest could be tax-deductible.  Fetterman does go on to explain that everyone should be investing for retirement, and at a minimum investing in a 401(k) to get your company’s match.  This is where a balanced financial plan comes into play and the decision should be based on what’s best for your lifestyle and long-term financial plan. 

Now let’s say you don’t have credit card debt, but you have a car loan and could pay it off with the money you have in savings. Do you?  Don Taylor, Ph. D., CFA, of Bankrate.com replied to this question by explaining that by drawing significant funds from your savings to pay off a car loan, you will not save as much interest expense as you think (depending on the cost, maybe around $500).  He says it is a much smarter plan to keep the savings in reserve in case of an emergency.  He does go on to say that if someone does pay off his or her car loan this way, the ideal situation is to use the extra money each month to replenish a savings account. 

And what about the “good debt” of student loans?  Many graduates start out with a considerable amount of debt, $20,000 or more.  Should this be paid off as soon as possible?  Lis Pulliam Weston, writing for Money Central on msn.com, says graduates should tackle credit card debt first, then other non-mortgage debt and then build an emergency fund, all while saving for retirement.  Once you’ve reached this point, she says it’s time to consider sending extra payments in for your student loans.  These loans typically have lower interest rates, so they aren’t as big a concern as credit cards. 

Overall, the consensus among financial experts is that paying off high-interest debt is the first priority.  Once that is accomplished, then move on to building an emergency savings account and paying off other personal loans.  Finally, once in sound financial shape, you can look at making more payments to your mortgage or student loan debt.