The rich rule over the poor, and the borrower is the slave of the lender. Proverbs 22:7
This is one of the most debatable personal finance discourses. Having extra funds at the end of the month, should you pay down debt or instead deposit it in some form of savings or investment account? The answer in most instances is dependent on an individual’s financial situation and their emotional relationship to money.
There is a school of thought held by many that says all debt is “bad”. The advocacy is to pay off all debt, credit card balances, car loans and even your mortgage as soon as possible. Indeed, there are valid reasons for this point of view, and from a behavioural standpoint, it’s a simple rule that’s easy to follow and works for some people. On the other hand, there is another liberal group that firmly believes you must “pay yourself first”. They argue that not all debt is created equal. A personal bank loan with a 14.5% interest rate is hardly in the same class as a 6.5% home mortgage. Pay yourself first persons believe there is “bad debt” and “good debt”. This group offers their own simple rule; if you can invest the money and earn a greater return than the cost of debt you are paying, why not save or invest it? After all, you will be paying bills the rest of your life; taking care of yourself first becomes a priority.
Here are some simple steps to consider in identifying the right course of action for yourself.
Evaluate Your Debts Make a list of all your debts showing the balances, minimum monthly payments and, most importantly, the interest rates you’re paying on each balance. Regardless of whether you consider yourself a “pay yourself first” or “all debt is bad” person, you’ll want to make sure you’re putting at least enough to meet minimum payment requirements. Then you can turn to interest rates.
Build an Emergency Fund It is said that the most expensive mistake many persons make is not planning for emergencies. The car needs new disc pads, or there can be the loss of your income due to a redundancy exercise. The exact nature of emergencies isn’t predictable, but having some form of emergency funds should be a guarantee.
Make a Debt Repayment Plan Once you’re meeting your minimal debt obligations, have built up your emergency savings and have maximised the extra money you get to save; it makes sense to take what’s left over each month and consider a blend of debt payments and savings/investment options. These options will be viewed differently by individuals.
When it is all said and done, the preferred route may be to maximise your savings and investment options as much as possible and take advantage of the low interest rate environment on your debts. However, I don’t always do things based exclusively on the numbers. There’s a psychological and relational aspect to the world of finances. It’s the psychological pull that motivates my decisions. I sleep better at night knowing I don’t owe someone money. It’s hard to put a price tag on a good night’s sleep! The sooner my debts are paid off, the less money in interest I have to pay and the more money I can keep, invest and give. In all my years, I’ve never met anyone who ever regretted paying off all their debt.