Pay Off Debt or Invest?

September 1st, 2008, by

Q: My only debt to speak of is a law school loan, currently around $50,000 at 2.6%, which will be reduced to 1.6% in three months as part of my consolidation agreement (36 on-time payments). I’m putting money towards retirement and saving for a down payment for a house and still have some money left over at the end of the month (kind of lucky to earn a good income without much responsibility). Of course I also have an emergency fund, just in case.

It seems like you and other personal finance advisers consistently advise consumers to pay down the loan debt. I know that there is no such thing as “good debt,” and most school loans have higher interest rates than mine, but should I be using my extra monthly income to pay down the loan when it has such a low interest rate? Math was never my strong suit, but it seems like I would be better off placing the money into an online savings account that earns more interest than my loan. Am I wrong?

A: Yes, you are wrong. One of the reasons this country is in an economic crisis is people were told to hold onto debt like it was a pet. But at least pets give you pleasure. People were also told to use debt as a tool to build wealth.

Well we see how wrong that advice was. We now see how debt isn’t a tool but is often a death trap. People now know that things don’t turn out the way they hope. People with interest-only loans found out that home values don’t always go up. People who used home equity loans-debt-to pay off more debt (credit cards) or invest, found out that investments tank and leave you with, well, more debt.

What’s wrong with holding on to debt is that you are holding on to risk. Why hold onto to debt when you have the ability to pay it off?

In your case, you are minimizing $50,000 in debt by saying, “The only debt I have to speak of is $50,000.” For me that speaks volumes-that you are $50,000 in debt.

Say the figure out loud-even if this question doesn’t apply to you.

Say, “I have $50,000 in debt.”

My heart jumped, and it’s not even my debt!

Could you earn a little more on the extra income you have by putting it into a savings account? Yes, but not much. Savings accounts, CDs and Money Markets aren’t paying that much. And you have to take into account that you have to pay taxes on the earnings. So for that little bit of money in a savings account, you are keeping a lot of risk on your personal books.

Now, some folks will advise you to invest the extra loan payments you might make. Seen the stock market lately? Investing means risk. Risk means you could lose the money. I have investments accounts and they are all down so far this year.

Right now, while you have fewer responsibilities-children, house, life-pay off the $50,000. I would even scale back retirement investing and, certainly, I wouldn’t be saving for a home when you have that much debt. It’s a lot to speak of.

Last modified: April 26, 2011 at 10:59 am