Should you pay off your debts or save for your retirement?
Scenario 2: When should consumers prioritize debt repayment
According to a recent report, the average credit card APR is 20%. If you carry a balance at a high APR, paying it off as soon as possible is essential. Or, at least, refinance it with a low-interest loan, line of credit, or balance transfer. A debt consolidation loan can also be an option. By holding onto high-interest debt, you are likely increasing the time it will take to retire, while negatively impacting your net worth.
Worse, if you make the minimum payments and invest the rest, keep in mind that your credit card balance may continue to increase and it could take 10, 15+ years to pay off. And no matter how much you owe! $ 100, $ 1,000 or $ 10,000. If you only make the minimum payment, the bank earns because of the potential $ 1,000 interest you give it.
Other high interest debt
Credit cards aren’t the only high-interest debt you might have. Other loans that may carry a high interest rate include payday loans, lines of credit, and other personal loans that may have high interest rates. If you have any of these loans, they should always prioritize saving for retirement.
Debt Snowball Method
When it comes to debt repayment, I find the debt snowball method to work well. It allows you to focus your efforts by paying off the smallest debt first, while the rest receive minimum payments. After you’ve paid off the first debt, you can move on to the next smaller debt. Repeat until you have no more debt, or at least no high interest debt.
There is rarely a good reason to continue contributing to an emergency fund if you have high interest debt. Pay it first, then focus on funding an emergency fund after. Some may have a different opinion, but, in most cases, and as a last resort, consumers can re-advance borrowed funds in an emergency. Once the high interest rate debt is fully paid off, consider create an emergency fund and invest in your retirement.
Low interest debt
Once the high interest rate debt is settled, you will either need to pay off low interest debt such as student loans, car loans, or your mortgage. Mathematically, it often makes more sense to invest money than to pay off low-interest debt. However, this is not a guarantee. Plus, regardless of the debt, high or low interest, there will be a payment associated with it. This payment eats away at your excess monthly income. Thus, the faster the debts are paid, the more money you can allocate to investments.
Financial advisor option
Going to a financial advisor is almost always a great choice. Advisors will often give you a perspective that you may not have considered. Also, they are personal finance experts and already know everything that is written here today.
Scenario 3: Balancing retirement savings and debt repayment
Can you have your cake and eat it too? May be! In some cases, it may be a good idea to pay off your debt and save for your retirement at a time. Admittedly, it will take you longer before you can pay off all your debts. However, if the debt has a low interest rate and comes with a manageable payment (i.e. a mortgage), yes, that makes sense.
Plus, if you have great credit, you might be able to get a lower interest rate on your mortgage by requesting or refinancing. With 30-year interest rates hovering below 3%, money is virtually free. By refinancing AND extending your amortization to 30 years, you will free up monthly income in your budget to allow you to invest more.
Mortgage Tip: Have a plan to pay off your mortgage, in full, right before retirement. This will not only help you sleep better at night, but it will free up a significant payment for you that will strain your retirement budget.
Final thoughts on debt and saving for retirement
Ultimately, the decision depends on how much interest you pay on your debt.
Before choosing either of these strategies, think about the psychological effects of having no debt or mortgage. For some, it is essential to live without a mortgage because they might think of the house as “the property of the bank”. Or, maybe the thought might be, “What if I lose my job?” In any case, it all depends on your level of comfort.
It should be noted that sometimes borrowers can enjoy certain tax benefits when paying off certain types of debt. For example, in certain situations, interest on mortgages or investments may be tax deductible. Tax deductions could result in a larger tax refund at the end of the year. But as always, always consult a qualified financial professional for the best advice!