It’s the age-old question about which comes first. (No, not the chicken or the egg. Well, maybe – it IS about your nest egg, anyway.) Should you pay off your mortgage or invest first?
While both are very tempting options, there are some major considerations to think over before making this decision. You don’t want to lose precious time building compound earnings on your retirement, right? At the same time, the feeling of being debt free – once and for all – is just too enticing to pass up.
It’s a bit overwhelming, isn’t it? This is the point where most of us tend to freeze up for fear of making the wrong decision.
However, remember that everyone’s situation is different, and only you can make the right decision for yourself and your finances.
Take the time to weigh these several important factors first when deciding whether to pay off your mortgage early or invest:
Consider interest rates on debt vs. the percentage of investment earnings.
Any investment guru will tell you that the market averages out at an 8% return on investments over time. But what’s the interest rate on your mortgage, credit cards, personal loans or student loans?
If the interest rate on any of your debt is 8% or higher it makes sense, in the very least, to pay off those specific debts first.
After that, take a look at what’s left. Is it a loan where the interest is a tax write-off, like your mortgage or student loans? Continuing to have that tax write-off could be beneficial, especially if the interest rate is much lower than 8%. In that case, switching to retirement savings could be the answer at this point. Not having those tax write-offs could be a disadvantage of paying off your mortgage early.
Calculate how long debt repayment will take.
Once you’ve created your budget and added up your debt, figure out how long it’s going to take you to pay off the debt in full. Are we talking about 8 months or 8 years? A rule of thumb is that if it takes longer than 2 years to pay off your debt, you’re likely to lose your motivation because it’s just too long of a repayment period.
I am a person who likes having a goal and a light at the end of the tunnel. I want to know how long something will take, and once I do, and I’ll focus on it with everything I have.
We’ve calculated our debt payoff to happen in April 2018 (pending no job eliminations). For us, that’s a short enough amount of time that it’s worth the tradeoff of stopping our retirement contributions for about a year to pay off this $26,619 in debt.
If it’s going to take you longer, say 8 years – that’s a lot of compound interest to miss out on in your retirement funds. Choosing to payoff debt and save at the same time will stretch out the repayment timeline a lot longer though, right? No necessarily. With a bit of creativity and hard work, you can find a side hustle you can do to pay off your debts quicker.
Your age (Yup, I went there.)
Your financial decisions as a twenty-something are going to be very different than your financial decisions at sixty-something. Or at least, I hope so! If you’re young and have 20, 30 or even 40 years left to invest, you’ll have plenty of time to earn that compound interest.
If you’re in your late 40s, 50s, or early 60s, it makes more sense to focus on your retirement. Time is unfortunately running a bit tighter to get all the pieces into place for you to enjoy your margaritas at your villa on the beach. Plus, you can use part of your retirement income to finish up those debts if you haven’t already done so.
This is a great time to look at an investment calculator to see if you’re on track and what adjustments you might need to make in order to hit your target.
Figure out your motivation. Or, what’s keeping you up at night?
To me, this is the biggest factor of all. Motivation. When you have it, it’s amazing and you can literally achieve anything. And when you lack it, even the most basic of tasks becomes a huge chore.
I’ve been dreaming of being debt free for a while now and it’s my driving passion (or some people call it obsession, but whatever). Allow your passion to help drive your decisions. Don’t dismiss your dreams and goals just because you don’t think that a financial planner would agree.
Motivation, or even fear, can be fantastic catalysts in helping you to achieve your goals. Seeing some positive change take shape helps your motivation to grow by leaps and bounds and you’ll meet your goals much quicker.
If you have the motivation and drive to knock that debt our once and for all, include that as part of your assessment of your financial situation. Or, if your dream is to retire and open a tiki bar on a tropical island (are you sensing a theme here?), then allow those goals to weigh in as well. Figuring out your “why” of becoming financially independent is key to deciding your next financial steps.
Bonus: You have access to an Employer match on a 401k.
At the very least, if you have access to a 401k with an employer match, you should always invest at least enough to get you the match. That is free money that you would be leaving on the table.
Plus, you’re putting money into the 401k pre-tax so that it’s saving money for you on your yearly taxes as well. If nothing else, if you determine to tackle debt first, then you at least have this employer match to start the compound interest ball rolling.
Remember that your decision whether to pay off your mortgage or invest is a personal one. It also doesn’t have to be all or nothing, black or white. You can mix and match what makes sense to you. While there’s no one-size-fits-all answer, you must do what’s best for you and your financial situation.
Have you decided between retirement and debt repayment? Which path did you take and why? Let me know in the comments, I’d love to hear your “why”!
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