Should I pay extra towards debts or invest that money instead? The answer to this question varies depending on each person’s financial goals, situation, and risk tolerance. In this article, we’ll run through a couple scenarios and discuss the factors to consider in each situation.
Let’s start with someone who’s top priority is maximizing cash flow and net worth. For this person, the interest rate on the mortgage vs. the projected return of investments should be the primary consideration. Using this example, let’s say they have a mortgage at a 6% rate and their projected rate of return on investments is 4%. Given their goal of improving net worth, I would consider paying extra on the mortgage due to the mortgage rate being higher than the projected rate of return on investments. Vice versa… if they have a mortgage at 4% and their projected rate of return on investments is 6%, then I would consider saving/investing the extra instead of paying down the mortgage due to the projected return of investments being greater than the mortgage rate. The principle of interest rate on debt vs. projected return on investments can apply to other debts as well such as car loans, credit card debt, or student loans when you have a goal of improving cash flow. (1)
Now let’s say we have someone who is a few years from retirement, already has a large retirement bucket built up, and their top goal is to pay down the mortgage before they retire. In this situation, it makes sense to pay down the mortgage faster because they want to prioritize eliminating debt over accumulating money. In this case, the numbers are not the deciding factor because their focus/goal is paying down debt.
The emotional side of this question matters as well. Some people lose sleep over debt payments or risk, and this can be an area of significant stress for them. In that case, it often makes sense to put more focus on the debt payments instead of savings/investing. People have different tolerances for risk and the emotional side of this question matters as much, if not more, than the numbers side of it.
Overall, it comes down to one thing: what your goals are. Factors to consider when making this decision are risk tolerance, interest rate on debt, your projected return on investments, and life of the asset secured by the debt.
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