Debt

I recently read two articles within a day or two of each other, both about debt. One basically went right for the throat and provided very little wiggle room (other than setting up a cash emergency fund) around the idea of paying off all debt. The other more or less said that if you feel that strongly about it, I guess, but you can make more money by investing the money in something else with a higher return than the interest rate you're paying.

Are we still debating this in 2019?

Pay off your debt...

If you look at a student loan with a low, tax-deductible interest rate or a similar situation with a mortgage, it can be tempting to want to invest the money you could use to pay down the principal to earn a 10% return, compared to the 3-5% interest rate you're paying.

There are a few problems with that. The first is that if you're investing in long term retirement accounts, you can't get to that investment for up to several decades when you actually retire without losing all that extra return and probably more. This puts you into a major cash flow crisis, where you have assets but no cash.

The second is that if you're investing in something like stocks and mutual funds that aren't part of a retirement account, you're going to be paying capital gains taxes on those returns, again eating away a chunk of your earnings.

The third is that with recent tax changes, much of the middle class is no longer itemizing, so the marginal tax savings for charitable contributions and mortage or student loan interest is not what it was. It was always a bad idea to hang onto a mortgage just for the tax deduction (spending $800 to save $200 makes no sense), but now even that carrot is largely gone.

The fourth is that when your house or car or any other large asset that you need is the collateral for a loan, you risk losing that item. The article in favor of keeping around your mortgage anchor basically said that peace of mind might be worth it to you, but you should really think hard before making such a poor decision. This isn't just peace of mind. This is your house. If you can get your housing expenses down to no more than utilities, taxes, insurance, and maintenance, you're still paying out of pocket monthly, but a doable amount that you can work through if there is a disaster of some kind.

The final item is a positive, rather than a negative. I know there are huge differences in what people are paying for mortgages or rent, but let's go with a nice around number of $1,000 per month. In most places, people probably pay quite a bit more than that. Ignoring for just a minute the idea of principal vs. interest, just look at the cash flow of $1,000 per month going out of your pocket to the bank. You can save up $1,000 per month to do whatever you want with it if the house is paid off.

If you have 120-150k in some account earning you 10% interest, you are going to end up with about 1,000 per month from that investment. But it all goes into the house payment. If you take that 120-150k and finish paying off your house, you aren't making the investment income, but your expenses also go down by $1,000 per month. Reducing your investments and your debt by the same amount also reduces the risk of holding that debt.