Oh, the classic dilemma. Do I Invest or pay down debt with my money? I want to make the best decision possible. The way I look at it, there is a few main categories to consider.
When we invest in the stock market, we can make 8% per year and a car loan could have a 3% interest rate. We will assume we have $10,000 to use. Do we pay off the car loan or invest it? In the stock market, in year 1, we will assume we make $800. Paying off the car would save us $300. With $800 being larger than $300, this is why a lot of people like to invest as much as possible first.
Now let’s look as the same example. Assume we are paying $300 a month towards the car payment per month. If we pay off the car loan, this will increase our cash flow by $300 per month, or $3,600 a year. The stock market, even with the 8% yield, will give us $800 a year in free case flow. So, paying off the car will give us a lot more free cash flow. This is the reason why people like to pay off debt first.
Sometimes it depends on the interest rate. Say you had to take on a 20% interest rate loan or more for some life event. That is a large interest rate. At that point, it may make a lot more sense to pay off that loan first. If you have a loan at only 2% interest rate, it can make a lot more sense to invest your money and pay the minimum amount.
These 2 options have risk to them. When we pay off the loan, the savings are locked in. However, the money is gone and we cannot use it for other opportunities. If we invest the money, we have an opportunity to make a lot more money than paying off the debt. However, investing has the risk of losing money.
If we have a low credit score, paying down the debt can make a lot more sense. If you have too much credit card debt or too many other loans, this can make your credit score lower. By paying down your credit cards or paying off some of your loans, this will improve your credit score. By improving your credit score, it will help you save even more money. The next time you get a loan, your interest rate will be better. Sometimes, when you get a new service, a credit check is done. By having a better credit score, you can get better terms, even though you are not paying an interest rate.
Do I Invest or Pay Down Debt Conclusion
When we were starting down our career path, we focused on paying down debt. We had student loans and car payments taking up a lot of our flow. As we improved in our career and paid off some of our debts, our free cash flow improved.
Even though we have not paid off all of our debts yet, and unfortunately have picked up new debts, like a mortgage and another car loan, we have a balance approach to paying extra towards our debts and investing. How much we focus on paying down debts and investing does change over time. If one of our debts is almost paid off, we will focus on getting rid of it quickly. If the stock market is having a correction, we start putting more money into our investment account to be able to buy more stocks. Having flexibility helps as different opportunities arise.
Do I Invest or Pay Down Debt, that is the question? Do you prefer to invest or pay down debt first? Is there any other consideration we should think about? Please feel free to share your thoughts on investing or paying down debt in the comment section below.