Decide Whether To Invest Or Pay Down Debt With This Question

Decide Whether to Invest or Pay Down Debt With This Question

If you can swing it, paying off your mortgage early sounds like a smart enough idea. But some prefer to invest rather than throw cash at outstanding, low-interest debt. The idea is, if your debt's interest rate is lower than your investment return, you come out ahead. Here's a simple way to decide if this route is right for you.

Photo by Images Money.

Balancing investing with debt goals is trickier than it sounds, but can prove highly successful for those who pull it off. This post tells you, in detail, how to best balance these two goals, depending on your situation.

One option we mention is investing when you have a low-interest loan or debt. In particular, a lot of people skip paying off their mortgage early, opting to invest for a better return. In their 2015 Investment Guide, Forbes explains:

The main disadvantage to a mortgage prepayment is that it is a very illiquid investment. Once you have sent the money to the bank, you can't get it back without a refinancing. that would entail closing costs and a possible loss of your interest deduction.

Of course, the risk of going this route is that, well, there's risk. A buy and hold investment portfolio is pretty safe, but that doesn't mean it's not still susceptible to the ups and downs of the market. Paying off your mortgage, on the other hand, is guaranteed. You'll have a smaller mortgage. To help decide if you're up for the risk, Forbes suggest asking:

Suppose your mortgage were paid off. Would you take out a $US100,000 home equity loan and invest the proceeds in stock right now?

Of course, if you're buying and holding, your portfolio will almost certainly bounce back over time. Still, paying off your mortgage means less debt; there's nothing uncertain about that. In deciding which option is best for you, this question will help start you in the right direction.

Forbes - June 29, 2015 - 2015 Investment Guide - Special Issue: 137 Ways to Get Rich


Comments

    How common is it that you investments will provide a greater return than the interest rate you're paying on your mortgage?

    Interest rates have to sit higher than average investments otherwise the banks wouldn't do them, and it's almost pure luck to perpetually choose "above average" investments.

    Mortgage, all the way. Then once that's paid off, invest away!

    (I'm not a financial adviser, but I am the proud owner of a mountainous mortgage that I won't be betting against anytime soon).

    This advice is pretty bad, for the following reasons:

    1) It's American and you can't compare their home loans to ours (eg 30 years fixed at 2.5% - how good would that be!!!)

    2) Based on that, no wonder investing looks attractive

    3) No mention of 100% offset accounts which removes the illiquidity problem. Pay the minimum off the principle and the rest into an offset

    4) ...if your debt's interest rate is lower than your investment return, you come out ahead MUST take into account the tax component of your investment. If you're in the top bracket then you've basically lost half your investment profit meaning your investment rate needs to be close to double what your mortgage rate is to come out ahead. So the average punter with a mortgage rate of 4% needs to have an investment earning just under 8% GUARANTEED to break even. There's nothing I know that guarantees (ie bonds, term deposits) a return anywhere near that currently.

Join the discussion!

Trending Stories Right Now