Should I Repay My Debt or Invest My Money?

The following is presented for informational purposes only. 

Which is better, paying off debt or investing your money? There’s no quick and easy answer to this question. The decision involves some comparison between what your debt is costing you and what you expect to make in return for your investments. It also involves taking a close look at your financial situation. 

When deciding between debt repayment and investing, here’s what you need to think about: 

Consider the type of loan and payment details

To determine the best use of your money, you'll need to weigh the unique benefits and costs on the table. The best place to start is to review the details of the various debts and loans you're thinking of paying off.

Pay off credit card debt or invest?

Credit card debt is usually the most costly kind of debt to carry on a per-dollar basis because the interest rates are likely going to be way higher than any of your secured debts. The higher the credit card balance and the higher the annual APR, the more you'll be paying each month in interest charges.

Because of this, credit card debt should probably be your first priority when trying to figure out what to do with extra funds. Looking strictly at the cost of your credit card debt, it's unlikely that you'll find a low risk investment with the kind of positive return that's more profitable than your credit card debt is costly. That said, there are some scenarios where your credit card debt may not be the priority:

• If you're on a low interest/0% APR promotion
• If you're carrying a low balance with plenty of credit limit left over

In other words, if you have a reasonable amount of credit card debt and it's not costing you a lot or causing issues for your credit score or monthly budgeting, it may not be a bad idea to look into investment opportunities.

Pay off mortgage or invest?

A mortgage is itself a form of investment, assuming the value of your home increases over time. So while you'll be paying off your mortgage for many, many years, you'll at least have something of value to show for it in the end.

Given the opportunity, should you pay off your mortgage early? Unlike credit card debt, the interest rate on mortgages is usually quite low, so the per-dollar cost of the debt isn't that high. And while you will be paying a lot in interest charges over the life of the loan (because mortgages tend to be hundreds of thousands of dollars), paying off your mortgage early will likely take quite a bit of money. And, while it's not entirely common, some mortgages do come with early payoff penalties that may change the calculations.

Therefore, assuming you've got an affordable mortgage, it's probably not a priority to get your house paid off ASAP. If you can effectively grow your wealth through investment and keep your mortgage on schedule, it may be better to do just that.

Pay off student loans or invest?

Student loans somehow manage to split the difference between credit card debt and mortgage debt. They're unsecured, and while they aren't necessarily a bad investment, the debt isn't tied directly to an asset that will gain in value over time. Like mortgages, the interest rate on most loans is pretty low, making the cost of carrying student loan debt relatively low.

Whether or not you should focus on repaying your student loan debts may come down to the type of loans you've taken out. Federally-backed student loans usually come with lower interest rates and may be eligible for certain forgiveness programs, while private student loans function like regular unsecured personal loans. There are too many potential variables to make a blanket statement, but broadly speaking you should probably focus on your student loans first if they're:

• Too difficult manage and afford, month-to-month
• Not eligible for a loan forgiveness program
• More costly than the potential earnings from a low-risk investment

Do the math

No matter what type of debt or investment you're weighing, deciding how to best use your money is all in the calculations. Start by looking at the debt in question and calculate exactly how much it will cost you to pay it off. Be sure to include any interest, fees, and penalties into these calculations. 

Try using the debt calculator over at Credit Karma. It’s a handy way to see how much your debt is costing you, and how much you can save by increasing your payments.  

Next, take a look at your after-tax rate of return on any investments you may be considering. Unless you’re investing in a tax-free bond or a tax-sheltered account, you will most likely need to pay taxes on your earnings, which could decrease your actual return, so keep that in mind. 

Since the question is whether to repay debt or make an investment, you want to compare two numbers: the difference between the cost of your debt (primarily interest charges) with this hypothetical additional payment and the cost of your debt without any extra payments; and the potential return on your investments.  

We want to know if putting this pool of extra money into debt will save us more money than it could earn as an investment. That’s not the whole story, of course, but finding those two numbers will help provide an objective, numerical baseline for your decision. 

Examine your financial situation

If you’re carrying a lot of high interest credit card balances, paying off these debts may be the better way to go for now. Paying off those debts will not only save you money (that you can later invest), it can also help improve your credit score. If you’ve been struggling to balance your finances because of debt payments and building strong credit is a priority for you, then debt repayment is definitely the smart option. 

If your debt is manageable and your interest rates are low, however, investing some of your funds might be a wise option. Especially if those investments are part of a long-term savings plan and you manage your risk. 

Before making the final decision though, it’s wise to make sure you have ample emergency funds set aside. When it comes to investing, the funds you set aside are usually difficult to access, at least for a period of time. And if you have to withdrawal those funds early, it may come with a penalty that could eat into your returns. 

Consider another option

There’s one other option you can consider and that is finding a middle ground. Use some of your funds to pay down debt, especially the high-interest loans, and some to invest. This way you can achieve both goals at once. Budget for paying down your debt with as much as you can manage each month so that you can get it paid off faster and avoid interest fees. Then start investing by taking advantage of your employer’s savings plan, like a 401(k), where your employer matches some or all of your deposits. This way you can deposit twice as much into your investment account while still paying off those heavy debts and increasing your credit score. 

When it comes to making a decision to repay debt or invest, look at all options, do the calculations, then make the decision that works best for your financial future.  

If you need more help understanding how to tackle your personal debt, consider speaking with a certified credit counselor. Counseling is free and includes an objective review of your finances, along with suggested resources and next steps to help you reach your goals.