Very few people equate frivolous expenses as lost income. Knocking off a $500 a month payment is more than just getting out of debt; it's saving your money and boosting your cash flow. In these woeful economic periods, sometimes there is no such thing as a great investment – except for one in your own personal finances. As the global markets are tanking, it seems as though the best investment is in your own debt, whether that be credit cards, car loans, or maybe even the home. Eliminating debt will not only save you thousands in interest charges, but it will free up more monthly cash flow and put you in a better retirement position.
Consider this: you have $20,000 you would like to invest, but currently hold $15,000 in credit card debt. While you’re interested in setting a path for retirement, you also have to consider how much debt you’re holding. Paying off the credit card debt will save you a $300 a month payment, as well as knock off an interest rate anywhere from 10-20%. On $15,000, credit card rates really start adding up; even a modest 10% rate sets up $1500 a year, or $125 per month in interest charges.
Paying off debts now while the market is in decline will give you more cash flow to invest when the market starts turning around. Below is a list of debt types and how paying them off will be advantageous to your financial future.
Credit cards should be the easiest of debt to eliminate. Too many people are sucked into the idea that they’ll pay off their balances when they have more money. Chances are that you’re unlikely to have any more money until you start paying off the balance. Adding an extra $50 per month to a credit card bill in a crunch, or even a one time payment of $1000, will reduce your monthly payments and allow you to dedicate more resources to the principle. If you currently have a credit card with a 2% minimum monthly payment and a 18% interest rate, only a quarter of your monthly payment goes to eliminate principle.
If you can, dedicate as much as you need to pay off the credit card bills. The chances that you’ll earn a guaranteed 20% rate anywhere else is slim to none. Even as your monthly payments drop, continue to make the same payment. More of each payment will be dedicated to principle, further dropping your monthly payments. Compound interest works in two ways only: for you and against you. Paying off credit card bills will save you money and eventually free cash flow. Think of how much you could do with an extra $300 per month.
There are plenty of reasons to pay off the car loan. Their interest rates usually run higher than your mortgage, but generally lower than credit card rates. Second, the amount of insurance you carry can be lowered after the car is paid off. Generally, creditors ask that the car is covered for obscene amounts of money and against virtually any problem or natural disaster you can imagine. Paying off the car loan helps in two ways: you save money on interest and on the cost of carrying a car.
Your mortgages will likely be the last loan you ever have, generally spanning thirty years. The interest rates on home loans are generally lower than other lines of credit and often have generous repayment terms. There is no reason to payoff a home loan before starting your retirement planning; the interest on these loans can be easily beaten over the long term. If you are interested in paying off a loan as quickly as possible, consider a 15 year loan instead of a 30 year. The interest rate will be lower, but you’ll have higher mortgage payments, and the home will be paid off 15 years faster than you had planned.
Student loan debt
This should either be at the top of the list or at the bottom of the list, depending on what kind of student loan debt you are holding. Like home mortgages, student loan debt may seem like it will plague you for your whole life. Retirement planning can be done around home loans and student loan debt, but consider what kind of interest rate you’re paying on your student loans. Federally backed student loans are cheap, currently as low as 6.2% per year, while private student loans can run as high as some credit cards. Paying off your debt to Uncle Sam should come long after paying off the bankers; however, corporate student loan issuers like Sally Mae charge rates that are significantly higher than government programs.
The kicker: Student loan debt is hardly a talking point when you apply for a line of credit, either for a home loan or any type of large installment debt. In a sense, student loan debt is kept off the books when you apply for a loan. Student loans are unlikely to affect your credit (unless you’ve missed payments), and it shouldn’t hurt you when looking for other credit lines.
Eliminating debt is never a bad investment
Eliminating debt in any form is a strong long-term financial strategy. It will cut down on your monthly expenses, allow you to save money by cutting in other places (such as insurance), and give you a stronger bottom line in your savings account in the long-run. Starting with the high interest items and working down the list of highest interest, it would be wise to pay down any interest-bearing loan that is greater than 8% per year. For rates lower than 8%, you are likely to get a higher return in the market than in your own debt. However, anything above 8% per year is a free guaranteed return; take it now and put the proceeds in the market when it starts turning around.