After her husband nearly died from complications from surgery, Liz Gendreau and her family decided to completely free themselves from their debts. The goal was to protect yourself in case something similar happened, says Gendreau, 38.
After pay off high interest debt, Gendreau attacked his mortgage by refinancing it for a term of 15 years and at an interest rate of 2.75%. Today, the extra cash is held in a “mortgage repayment fund” which also serves as an emergency fund. “It can be used to pay off the mortgage all at once once it hits the mortgage balance,” Gendreau said.
Although Gendreau, who writes about his family’s financial situation on his Chiefmomofficer.org blog, knows that paying off his mortgage may not be the mathematically wisest way to spend the extra money, it does gives the peace of mind of knowing that a home loan won’t hang over the heads of one’s family in another emergency.
“For me, it’s more about safety than anything else,” says Gendreau.
Gendreau is not the only one who wants to reduce the debt. Financial experts and money gurus love to extol the virtues of quick debt repayment. And they are right. Interest payments are expensive, especially for high rate loans such as credit cards. And neglecting due dates can result in penalties and fees.
But preaching total debt aversion can overshadow some of the mathematical complexities and nuances of wise financial management. After all, most consumers have goals other than paying down debt, including financing their retirement, saving for their children’s school fees, or building a strong emergency fund. Focusing on debt to the exclusion of these other goals can be a misguided financial strategy.
“To say all debt is bad… that’s too broad a statement,” says Shashin Shah, certified financial planner and director of SFMG Wealth Advisors in Plano, Texas.
So while carrying debts may not to feel great, it can be a wise financial move when made in the service of other financial obligations. For example, if you are relatively young, have a 4% interest rate on your home loan, and expect to earn 8% per year on your retirement investments over the next several decades, it could be worth the worth spending additional funds on Pension saving, not the mortgage repayment. Or if you are planning to go back to school and need to take a reasonable student loan debt amount, it could be a worthwhile investment in your future. “It all has to be looked at holistically,” says Jamie Ebersole, a certified financial planner in Wellesley Hills, Massachusetts.
The idea here is not that debt is good, but that you should be thoughtful and aware of the potential tradeoffs when you are aggressively paying it off or avoiding it altogether. Here is what you need to know to eliminate your fear of debt.
Not all debt is created equal
If you are passionate about paying off debt, you know that not all debt is the same. “Interest rates matter,” says Stephanie Genkin, Certified Financial Planner and Founder of My Financial Planner LLC in Brooklyn, New York.
Some experts like to classify “good” and “bad” debt. While this can be a simplistic way to label loans, and some obligations can fall into both categories depending on individual circumstances, it can be a useful way to mentally categorize your debt load. Consumers should almost always avoid having “bad” debt, such as high interest debt. credit card, payday loans and high rate auto loans. But “good” debt, like a low-interest mortgage, low-cost car loan, or low-interest student loan, can give you slow repayment.
It’s worth considering whether your money could work harder for you in an investment account or emergency fund. “Leverage is a very, very big key,” Shah says. For example, if you leverage a $ 200,000 mortgage properly, he says, you understand that you may be better able to use the $ 200,000 independently by investing or saving rather than spending it all on the fund. reimbursement of your home. You also understand that the house may be worth more in the long run than the debt ultimately costs.
Of course, Shah notes, this carries some risk. After all, your home or your investments could be losing money. But if you stay in a home for a reasonable number of years and invest wisely for your time horizon, you can mitigate those risks.
Audit your debt
How do you know if the debt you have is worth paying off quickly or can be de-prioritized in favor of smarter financial strategies? Do an audit of your debt to determine which loans carry the highest rates and which carry variable rates, which means they could become more expensive as interest rates rise. These are usually the debts that you have to pay off first.
On the other hand, when considering taking on new debt, think about the potential payoffs. Carry credit card debt, for example, is almost always a bad financial blow. But borrowing to buy a home or attend college for a reasonable price can be a wise investment in your future. If you can handle the monthly payments in the future, this type of debt may be worth it.
Also consider your relationship and your ability to repay your debts. If you have a toxic relationship with paying down debt or having an inconsistent salary, perhaps paying off debt is the best decision, even if it is low interest debt because you know you can’t handle these payments unless you do it aggressively. . But if you’re responsible for your debts, have a good credit score, and think your money can work harder for you in other ways, it’s worth thinking twice before speeding up your repayment. , say the experts.
Consider savings goals
Paying off debt is a flagship goal, experts say, but remember that other financial goals are important and may need to be balanced with aggressive loan repayments. Experts note that investing can be intimidating and risky compared to paying off debt, which looks like a guaranteed return. “People don’t know how to start investing, and they see daily stock reports on the ups and downs, and it seems like a dangerous place there,” Genkin said.
Funding a retirement account is a big financial obligation, and the sooner you can start investing in your retirement fund, the more time you’ll have to allow interest to accrue. “The question is, can you earn more with your money than you can service your debt? Shah said.
Consider your stage in life
Your age and how close you are to retirement can affect your approach to debt. “There is a time when it makes sense not to go into debt,” Shah says. “We don’t think it makes a lot of sense to carry a big mortgage until retirement.”
If you are just starting out, it may be a good idea to slowly pay off mortgage debt or student loan debt in order to achieve other goals, such as build up an emergency fund or retirement account. But as you get older in retirement, paying off debt is often a more appropriate goal. Ultimately, you need to weigh what makes the most mathematical, emotional, and financial sense, and then choose your approach to debt wisely.