When you start digging into the world of debt, it seems like a no-brainer: If you have debt, you should pay it off early. But should you pay off all debt early?
We are a nation in debt, with data indicating that outstanding consumer debt, as of July 2014, was $3.24 trillion. The revolving debt (mostly credit cards) in the United States is at $840 billion. This, Nasdaq.com points out, is the combined GDP of Denmark and Belgium. And that’s just revolving credit and consumer credit. Those numbers don’t even include mortgage debt, which sits at $8.07 trillion as of September 2014.
The solution seems to be to pay down that debt as soon as possible. After all, if you are paying interest to someone else, you’re lining their pockets, and not your own. But does it always make sense to pay off all debt early? Should you rush to pay off that 30-year mortgage in 10 years, or pay off that five-year auto loan in three years?
Surprisingly, you might be better off keeping some types of debt to term.
Low interest and tax-deductible
“Generally, you shouldn’t attempt to pay down debt at an accelerated rate if the loan interest is tax-deductible, and if the rate is low,” says Greg Lessard, a retirement planning counselor and president of Aspen Leaf Partners. Lessard also suggests that if you have a low debt-to-income ratio it might not be worth it to speed up your debt repayment and pay off all debt.
He points out that for most consumers, home mortgage interest and student loan interest is tax-deductible. As a result, if you could put your resources into an asset that offers you a higher return, you are better off investing the money than putting it toward accelerated debt pay down to pay off all debt early.
Trace Tisler, a certified financial planner and founder of Epic Financial, agrees that loans with low interest and tax deductions shouldn’t be paid off early — if you are just looking at the numbers when considering if you should pay off all debt.
“If the interest rate on your loan is lower than what you could reasonably expect from another investment, than extra payments applied to the higher yielding investment will lead to a better financial result,” Tisler says.
Of course, the key is the low interest rate. If you’ve got a high-rate loan, it makes sense to pay it off as quickly as you can. You might be able to invest your money and see a return of 7% or 8%, and that beats paying off your 4% rate mortgage early.
It might even make sense from a student loan perspective, depending on what your rate is. Even a car loan, which doesn’t have the tax-deductible interest of a mortgage or student loan, might be worth hanging onto if you are only paying a 3% rate, and you could put the extra payments into a tax-advantaged retirement account instead.
Emotional aspects to pay off all debt
Tisler acknowledges that, even when the math makes sense, sometimes paying off debt early is a psychological or emotional choice.
“The tougher answer is to find the value one places on peace of mind,” he says. “The peace of mind that comes to many when debt is minimized or eliminated may far outweigh the mathematical answer.”
You might be able to make more money if you keep the low-interest, tax-deductible debt to term and invest what would have been extra payments. But how do you feel when you have that debt hanging over your head, and the monthly obligation to make payments?
For some people, the fact that they don’t have to worry about repossession when they pay off a home or a car early is worth more than a better financial return on investment and will encourage them to pay off all debt.
Consider your own priorities and finances, and then determine what is likely the best course of action for you and if you should pay off all debt early. In some cases, it might not actually be paying off your debt as quickly as possible.