Have you thought about paying off that credit card debt lately? Been interested in investing in real estate or other forms of investment? Have owning apartments been on your mind? We are going to go over a quick and dirty way to look at whether you should pay off your debt or invest those funds first.
What Is Your Debt?
Let’s assume that you have a few different forms of debt. You have some credit card debt that you are paying 18% interest on, some student loan debt that you are paying 4% interest on and an auto loan that you are paying 6% interest on.
Looking at all of these debts, the easiest way would be to pay off your highest rate first. This amount could be accruing the most interest and you would be wise to pay off the debt that accrues the most interest on a regular basis.
What Is Your Investment?
Now lets, assume that you are looking into investments. We know that the stock market has a historical average return of 7%. You are also looking into real estate investing. Assuming you purchase the deal correctly, let’s say that you are going to earn around 8% return.
Interest Rate Arbitrage
If we are looking at this from a 30,000 foot perspective, without knowledge of any of the actual account balances, the immediate response would be to pay off that credit card debt first. Why? Because you are paying 18% interest and your highest investment return would come back at 8%, which would still put you upside down, around 10% assuming those balances are the same.
Once that is taken care of you only have two debts left: one at 4% and one at 6%. Given that you can invest in real estate and earn an 8% rate of return, you would have the ability to make about 4% more than your student loan debt and about 2% more than your auto loan debt. Because of this it would be more wise to invest the funds that you have and earn the higher interest rate, then use that extra income to pay down your debts, however, let’s assume that the neighborhood around your real estate investment comes to have some catastrophic failure and now you don’t have anyone that wants to live there, and your investment return goes down to 1%. It would be better in this case to pay off those debts and then invest the funds (or move them to another investment vehicle if possible).
Not An Exact Science
Again, we see this as a very quick and dirty way to determine whether you should pay down debt or invest your funds. In order to truly find out what the decision should be we would have to take into account the balances of those accounts and weigh that against possible returns that you may earn; doing this can give you a very good and accurate financial picture of which way to go next.
Who Do I Talk To?
You can always come to us with any questions that you have and we can give our opinion, but we would also recommend that you speak with your financial adviser to go more in depth to your personal financial situation and give you a more detailed analysis. If you do not have a financial adviser, or would like referrals to a few, feel free to contact us.
Until Next Time,