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~Want to “Make” 25% per Year on Your Money?
Pay Off Credit Card Debt or High-interest Loans~

 

As a generally rule, one should probably only carry debt long term if:

 

1) the things you're using debt to purchase bring you some significant and lasting benefit, 

2) you can afford the payments, AND 

3) the interest rate on the debt is lower than the rate of return you are earning on your investments.

 

The last point is perhaps the most overlooked.  

 

Credit card interest rates are exceedingly high.  Currently, according to Lending Tree, interest rates on new credit cards are 24%.

 

Historically, the stock market has an average return of about 10% per year over the last several decades.  And if you have money sitting around in a bank account, it's going to earn much less, on average, and potentially close to 0% in a checking account.  So, if you have cash sitting around earning close to nothing and you don't need access to it, or if you are contributing to a retirement account, you may want to look at temporarily diverting those funds to pay off high-interest-rate debts.  Why pay 24% interest on a credit card so that you earn 10% in the stock market (or potentially even less on some other investment) in your retirement account.  Paying down the credit card will likely be a much better choice as this will, historically speaking, net you a 14% gain per year.  That is an amazing “return”.  Just don't forget to start your retirement contributions back up once you've paid down that debt.

 

And carrying debt is not necessarily a bad thing, and some people make the opposite mistake that is illustrated in the scenario above.  Say one has student loans that have an interest rate of 4%.  One may not want to rush to pay off those loans early.  Instead, one should compare the interest rate on the loan to the rate of return that one could get on any extra loan payments if those extra loan payments were instead invested.

 

Paying off the debt more quickly than necessary may not actually be the best financial decision, though it can certainly feel really good to eliminate debt.  The same goes for paying off your mortgage early.

 

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June 12, 2023