Once you have some extra cash, most people wonder what they should do with the extra cash they have. Should you pay off your debt, or at least pay down the debt that you have accumulated or is it better to invest the extra cash that you have and put the money to work for you. This is not a cut and dry question, depending on your circumstances, either choice could make sense.
When it’s best to pay down debt?
There are many reasons that you may want to pay down your debt, instead of investing. One of the reasons we discuss further below, is that the return on your investments is more than the cost of your debt. Considering the average credit card interest rate is 17.87%. Since investments can’t give you that type of return. It is usually best to pay off high interest credit card debt first.
Another big reason to pay down your debt is to improve your credit score. Your credit score is very important to how much you can borrow and the interest rate the bank offers you. Your credit score affects your car loan and mortgage if you plan on getting either. Having a higher credit score means receiving a lower interest rate. If you have a lower credit score that means you will receive a higher interest rate and pay more interest over the life of the mortgage or the car loan. Also, depending on your credit score you may not receive a loan at all. Your credit score can affect many other facets of your life such as getting a job, your insurance premiums and renting an apartment.
One of the factors that affects your credit score is how much debt you have. If your credit cards are maxed out you are going to have a lower credit score. So, paying down or paying off your debt might be a good idea if you find yourself having tons of debt. Especially if you plan on utilizing credit – buying a house and/or car in the near future.
- If your debt has a relatively high interest rate strive to pay it down first
- Credit Score – especially If you want to borrow money in the future
- Helps you sleep at night
When it’s best to invest your money?
As a rule of thumb, if you earn more interest on your investments than the interest on your debts are costing you, it makes more sense for you to invest your money. For example, if you have a car payment with an interest rate of 6% and an index fund that is giving you a 12% return, you will do better if you invested your extra money.
However, if you have a high interest rate credit card debt at a 15% interest rate, then it is better for you to use your extra cash to pay down your debt.
Unfortunately, It’s never that simple. Since investments can be risky. One year your investment might be up 20%, then the next year it might be down 10%.
Your risk tolerance can also play a major factor in your decision. If you have a high enough risk tolerance than you might be better off keeping your funds invested.
- If you earn more money on your investments than your debts costs you, it makes sense to invest
- Risk tolerance
When it’s best to do both?
Normally the answer to the question is a combination of both paying down debt and investing simultaneously. It makes sense to do both if you aren’t saving an adequate enough money for retirement or an emergency savings account or if the debt you are saddled with is making you lose sleep at night.
Are you ready to invest? Check out these articles listed below.
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