There are very few Americans that don’t have some form of debt. A mortgage, car loan (or two), student loans, or credit cards are all forms of debt that the average American worker carries for years. With interest rates at historical lows, the temptation to obtain even more debt to purchase what a person wants is all too real, but at what cost?
Interest Used for Gain
Many experts argue that debt can be good. It can help us obtain low-interest loans, be used to invest and make money, or even purchase investment items such as rental property that can increase a person’s overall net worth and cash flow.
For example, if a person is given the opportunity to take out a home equity line of credit (HELOC) at a low 0.9% then reinvests it in a peer to peer investment company such as Lending Club at a 10% interest rate, they can make hundreds, if not thousands of dollars. But with investment comes risk and this particular investor must be willing, and able, to repay the debt himself if the investment does not pan out.
Since many people do not want to have the constant worry of this type of debt, they elect not to invest their home equity. This can be a good thing, claim other experts.
Refinancing Home Loans
Another tempting option to saving money is refinancing a home. However, in regards to paying down debt, this may not be as wise as it seems. Yes, a homeowner can save thousands of dollars on interest by taking a lower interest home loan, but if there is only 20 years left on a mortgage and the refinance puts the loan back at 30 years, that means 10 more years of payments. For those intending to be debt free at retirement, this may not be an option.
Rather, making extra payments or adding addition money to a monthly mortgage can add up quickly and leave a homeowner with a paid off mortgage well before retirement. Taking that money and applying it to other debt, and the same homeowner finds himself debt free and in solid financial shape entering retirement.
The Math of Debt
So, is paying off debt worth it? Experts still disagree. Many argue that leveraging any equity and reinvesting it into solid, reliable investment is the best thing to do to make money. This may be true, but if the goal is to pay off debt and not make money, then paying off any debt quickly will give the borrower a sense of relief and accomplishment.
Even if this hypothetical investor makes money over a period of years, their sense of stress over the borrowed money will not equal the good feeling they will have when debt is paid off. Since each person is different, paying off debt versus investing is a choice that can only be made by each individual. However, if the ultimate goal is to become debt free before retirement, then leveraging home equity to invest is not a wise choice for that person due to the risk involved. There is no risk involved when paying off debt.
Many people can actually feel a sense of regret when paying off a debt. There are many instances of people who had a low-interest rate student loan that was paid off early and then regretted the decision. They state that if they had taken the extra cash and invested it, they would have made more money in the long run.
Taking a low-interest mortgage loan of less than 5% for 30 years and reinvesting it in a stock market that is currently giving returns of 10% can be alluring. In addition, the tax benefits of mortgage interest add to the appeal. The same is true with any loan that is less than 5%.
However, stretched out over 30 years and the risk of investing in the stock market, this money-making plan begins to form cracks. What if the stock market turns bearish? What if plans change? What if this leaves a borrower with a mortgage well into their retirement years? Some debt is not worth the risk.
Advantages of Paying off Debt Early
Debt carries burdens for many that create stress and discomfort:
- The borrower is slave to the lender
- Debt requires recurring payments, even if your financial situation changes
- Debt causes bankruptcy when unpaid
- Debt hinders positive cash flow
All of these points can be dismissed when the temptation of making easy money is directly in front of investors. However, this only works for people who borrow money conservatively. Most people do not. Debt can quickly become a thorn in the side and quickly turn into a dagger. True freedom comes from being debt free.
Paying off Debt to Retire Early
For many working people, the dream of early retirement seems like a far-reaching dream. One thing is certain: If there is tremendous debt, early retirement, or retirement in general, will never be a reality.
Use debt wisely and pay it off early to ensure that retirement will be debt-free. Try to pay off a mortgage before retirement and never keep credit card debt. When one debt is paid off, don’t spend the money on intangible items like clothes or a long cruise. Rather, apply the extra cash to another debt.
Paying off debt is not easy. Struggles and deprivation to make an extra payment or denying an enjoyable vacation with a tax return refund are not fun, but the end goal of a debt-free retirement is. The opportunity to borrow money will always be available. Debt is just a few clicks away. The opportunities to pay off debt may not be as readily available.
Smart investing requires knowledge of debt and the risks associated with it. If you are unfamiliar with the risks of investment debt, then do not invest. Instead, pay off another debt and enjoy the sense of relief and pride in working toward your debt-free retirement goal.