Debt is only bad when you use it irresponsibly. Borrowing on bad terms like variable high-interest rates rates, spending it on items that don’t help pay for themselves, this is what makes it miserable. Most of us have been in the boat of owing tens of thousands of dollars and we barely even know what we bought.
But debt is a useful tool when used in a smart manner. It’s hugely helpful to have the power to make large investments (like a house or car) without having to save for years. You just have to be conscious about weighing the cost of having that privilege.
Nowhere is this more evident than looking at the amortization on a 30 year loan. It’s so sad to see people thinking they’ve made a canny financial decision getting a huge 30-year mortgage at a decent rate, only to realize after the first few payment that only like $200 out of their $2500 mortgage is going to pay off the principal. The rest gets wasted on interest. You end up essentially paying for the privilege of being the bank’s gardener for the first 10 or so years. Save for the down payment! Settle for smaller houses! Get that 15-year mortgage!
Not exactly true. Many REITS are posting higher dividends than that. It’s not risk-free, nothing with a return above savings-level is risk-free, but barring a catastrophe, it’s nice to collect big dividend payments every quarter.
I think that makes sense, to a point. But if it takes ten years to pay off all our debt (and it very well may - that’s $125,000 in student loans plus the car note), we’d be behind on retirement for ten years, we’d end up at age 50 way behind where we should be, and we’d lose out on ten years’ compound interest. Especially with the Roths which are tax-free when we take the funds out - seems to me we should be maxing those out in the very least.
What’s killing us right now is childcare. The plan was free childcare. Instead, because of the pandemic, we have to pay for a nanny, which is about three times the cost of daycare. We’re hoping to get into a daycare in early 2022, assuming the COVID risk stays low - at which point we’ll have a lot more to put toward debt or savings.
Oh yeah, I didn’t mean to say that simply paying what’s due on debt is savings, but that paying extra into the debt is similar to saving.
Yeah, child care can be killer. I had a friend who’s salary was just enough to cover child care. She stayed working though, because she knew that taking 5 years off would be a huge setback for her career. In her case it paid off, but she was at the start of a career with lots of room for advancement.
Hasn’t been a catastrophe in real estate in what, 12, 13 years? And it looks like they took a pandemic related beating in 2020.
Money is fungible. Money that pays off a 6.5% interest loan is the same as money put into a 6.5% interest investment. Debts compound interest too. If you don’t pay off debt (and of course you have no choice but to pay off some of it; your only choice is whether you pay it off FASTER than they insist) but put the money into retirement, the extra money in retirement is simply offset by debt. You are saving money quite literally for the purpose of turning around and giving it to your creditors.
The overwhelming issue is interest rate. A loan of 6.5% might not be worth paying off faster is there exists a really solid savings opportunity that is very lucrative (and “some guy told me” ain’t strong evidence) or is not only lucrative but comes with a tax benefit. 6.5 isn’t so high that there might not be other opportunities that are a bit better. Loans in double digits, however, will effectively never not be better choices to put your money into. Credit cards are insane; if you have a credit card, pay it off before doing anything else.
While I agree that now isn’t the time to buy, I’ll quibble on this. If you have the cash flow for a bigger loan, and if you have some place to park your money that pays more than the mortgage rate, putting relatively less down lets you leverage gains better. Unlike most things, all gains in value for your house go to you, none go to the bank.
Plus, it is often good to have some available capital, and as you income increases the percentage of it that goes to a mortgage decreases, making the house more affordable - unlike the case of renting.
It of course depends on someone’s situation, but paying more shouldn’t be a hard and fast rule.
An interesting article on two different approaches: lowest balance versus highest rate:
There is a big psychological boost to getting rid of one debt entirely, though it may not make the most sense mathematically - the article looks at the two approaches.
That’s also only true if you actually do it. I know that, theoretically, I could probably find a better return than my mortgage interest - but the mortgage interest takes absolutely no work from me whatsoever (or, it took 5 minutes several years ago, and now it takes no work from me whatsoever), while actively remembering to invest and manage the investments takes some work and is less likely to actually get done. It becomes something I meant to do while the money either gets spent or just sits in my bank account growing little-to-no interest.
This used to be true for student loans, but isn’t anymore if you are on income - based repayment. Currently our loan payments don’t even touch the principal. At the current rate they will never be paid off, and will only accrue interest, and then allegedly will be forgiven after 20 years. I have us set up for the minimum payments, but have been trying to pay them off one at a time. In this manner we have paid off $50,000. It’s not nothing, but we still have a long way to go.
People are always going to disagree on this, but the disagreement always comes down to whether your goal is to lose less money via interest, vs. the psychological benefits of retiring entire small accounts.
Of course, not losing money ought to be a priority. The whole point of debt reduction is to get wealthier faster. But it’s also a disciplined habit, and habits can wax and wane. So if you think your habit of debt reduction is not reliable (a realistic assumption for some), then it might make sense to knock out small jobs first, to help stay motivated when your commitment is down.
As you can see I am not really excited about “psychological benefits.” Sure, it can help a habit stick, but psychologics are not a thing I can put in a savings account. That’s why I don’t talk about it much. I advise my own kids to put their faith in math instead of psychology.
My answer is contextualized to the OP situation in the current economic environment
Many markets right now are overheated, so it’s not super realistic to expect big capital gains. 10 years ago would have been a great time to leverage big loans. Not so much anymore.
OP has high-interest loans that need to be retired.
About “parking your money”, much hinges on your definition of “park”. I interpret this as a reliably safe, low-effort vehicle like savings accounts, and those aren’t doing great right now. Like less than 1%.
Sigh. I specifically agreed that now is not the time to buy, and I specifically gave my definition of park - higher return than the mortgage. Which CDs today do not give.
Yeah. I’ve read for years here and other places how wonderful paying off your mortgage is. I paid off mine because the change in the tax law meant I got no benefit from deducting the interest, which raised the effective interest rate I was paying on it. I got no psychological burst of pleasure at all.
On the other hand, so much of spending habits IS emotionally based versus based on hard facts. And there’s a self-discipline aspect as well. So, we can’t discount that as a fairly significant factor.
Many years ago, we needed a computer. We had the cash for it - let’s say it was 2,000 dollars.
We could pay cash, and pay ourselves back every month, or we could take a loan (in this case, secured by the cash, so the rate is low). If we’re disciplined, the “pay cash, pay yourselves back” approach nets better. If we’re NOT disciplined, the “pay cash” approach leaves us at the end of the year with a depreciating asset and less cash than we started. If we take a loan, we pay a little more overall, but at the end we have the computer AND the 2,000 dollars.
Since I knew there was a pretty good chance that we would NOT be disciplined, we chose the latter option. It didn’t make mathematical sense but I knew our spending habits, and it worked out for us.
In your case, the “pay the lowest balance” might actually make a difference - as that’s the one you’re likeliest to be able to pay more than the interest alone. So its balance will actually reduce while the others increase.
I don’t know how it all works with the forgive-after-20-years rule (which I was not aware of) so that might blow my logic out of the water…
It’s a weird situation many young people are having to navigate these days. I think we’ve paid down his loans enough that the payments are starting to apply to principal but I’d have to check.
My husband is still pushing to focus on investments. He said the returns on one of our current IRAs was 13% in the previous decade and 7% the five years before that, all of which are more than the 6.5% interest on the loans. I have heard so many things from so many people I just wish there was an official manual that said, “Do X.” Sometimes I guess there isn’t an obvious best choice.
I don’t pretend to be any kind of expert on this. I did just buy a house, though, so I can offer two small anecdotes that might get you thinking.
The first one involves waiving a contingency. We wrestled with the idea of doing this, as it can lower the price while raising the risk. Specifically, when we made an offer on the house we ultimately bought, the sellers wanted us to waive the appraisal contingency. What this meant was that, if we agreed to pay $775k but the house only appraised for, say, $700k, we’d be stuck paying that extra $75k upfront, on top of our down payment, because the mortgage company wouldn’t cover it. And our inability to do so wouldn’t be a legal basis to back out of the sale, meaning we could lose our deposit. This really stressed us out. But also, we really, really wanted this house. And every other house we’d made an offer on had sold for $950k or more, and we despaired of ever owning at all in this crazy market. So we agreed. And, to our surprise, the mortgage company didn’t end up requiring an appraisal at all! We just got financed for the full amount. So that gamble paid off. Our realtor wasn’t as surprised; she had encouraged us to go for it. She also correctly predicted the ultimate selling price of every house we were outbid on–generally at least $100k over asking. Good realtors know the market and really earn their commission.
The second one involves making compromises. We had really wanted 3 bedrooms, 2 bathrooms, a yard, and a 2-car garage. We ultimately had to accept that we couldn’t get all that for what we could pay in the areas we wanted to live. We did end up getting everything except the second bathroom. That can be added on in the future. The other thing we compromised on was a shared driveway. We were apprehensive about that, and apparently so was everyone else who looked at the house. While everything around it got snatched up within days of hitting the market, at $100-200k over asking, this house sat on the market for two weeks without an offer and ultimately sold for the asking price. And so far, the shared driveway hasn’t been an issue. We’re friendly with our neighbors and we’ve been able to work things out. I still worry about the situation if they move, but honestly, if it hadn’t been for this “flaw,” we never would’ve been able to afford this house. So it pays to be open-minded about what you can live with.
Best of luck, and don’t let arbitrary things like birthdays rush you into a decision that isn’t right for you.
In the words of those investment bank commercials, “past performance is no guarantee of future results.” And in fact, we’ve had a pretty-much unprecedented decade or two of growth, but gravity is still a thing. So be careful.
My daughter does research on how psychology affects the math. And it does - people get things easily decided by math wrong because of psychology. And by people I mean MBA students who should know better.
So your kids should know the math, and know that the math rules, but be aware of how their psychology could lead to bad decisions.
I have a loss aversion problem. I’m in much better shape if algorithms do my trading, not me. Not to mention that monitoring the market does not give me any pleasure, so I need to pay someone to do it for me.
It’s worked out fine.
Example. My daughter and I taught a tutorial for 3 years on how behavioral economics affects engineering, specifically chip design and testing. We did an experiment on anchoring. The effect on top notch engineers was so strong that we got statistically significant results for n=20. We’re convinced we’re rational. We’re wrong.
I mean… yeah. Math tells us exactly which answer gets the highest return, but we’re consciously not gonna take that approach because… paying off whole accounts makes us feel better?
I’m not saying people aren’t psychologically flawed, I’m saying that math is the only way to compensate for it. If we retire low-interest debt because it feels good then this categorically seems like the opposite of compensating for bias.