My rule of thumb about debt is that if its interest rate is almost the same or higher than the return I’m getting from my investment then my money goes to pay the debt instead of the investment. An example of this is credit card debt since they normally charge a very high interest on the remaining balance. I use credit card for almost all of my purchases but I make sure that it’s fully paid before the due date. Using credit card for my purchases helps me monitor where my money is going and I also get cash back from it. But since the interest rate is so much higher than my average return in investment, I always make sure that I pay it in full.
If my return on investment is higher by at least three percent compared to the debt or loan interest rate then I will not aggressively pay off the debt. An example of this is my house mortgage and sometimes my line of credit. Some people like to pay-off their mortgage but I don’t really do that since my mortgage rates are normally lower than the rate of return that I get from my investments. For example, if my current mortgage interest rate is 4% and I’m getting 7% from my investments then I would rather put my extra money into the investment rather than putting that to further reduce my mortgage loan.
So it’s all about the level of interest rate of the debt or loan vs rate of return on investment. High interest debt is something you need to clear first before you can even start putting money in investment. If you have a debt or loans with interest higher than the average rate of return on the investment you’re planning, then you need to pay off the debt first. It doesn’t make sense to put your money in an investment that will earn you 7% per year when you have a debt that charges you 7% or more in interest.
As I mentioned, it’s fine to have low interest debt or loans when your return in investment is higher but remember that income from investments are taxable so your net return is actually lower than what the investment yields. So if you have an investment that has 10% rate of return and if for example a quarter of it goes to tax payment then it’s better to pay off a debt that is charging you 7% or higher rather than having that money in the investment.
It’s very hard to get out of high interest rate debt due to its compounding effect so try not end up in that situation. If you have a high interest debt, try to transfer or consolidate them into one that has lower interest rate. Banks regularly run promotions that you can take advantage to reduce your interest rate so check them out and see if those can help you.