Why You Should Pay Off Your Debt Before Investing in Stocks

Jared Dillian  |


Ever build one of those mortgage spreadsheets?

It’s a pretty good exercise. Here is the key step—open that spreadsheet and add up the interest you will pay over time, assuming you don’t make any prepayments.

The answer will probably blow your head off.

For example, on a $250,000 30-year 4% fixed rate mortgage, you will actually pay about $430,000 in total over the course of those 30 years.

Every butthead reading this is like, “But you get to deduct that from your taxes!”

I have never understood that philosophy. You would rather pay more money than less money so you can get some of it back?

True, mortgage interest is tax-advantaged (for now), but most of the money you pay in interest is unproductive. It doesn’t do anything. That is the price you pay for the ability to spend money you don’t have. And it is expensive.

Credit card interest, also unproductive. Car loan interest, unproductive. Student loan interest, unproductive. Who has ever been happy about the hundreds of thousands of dollars people pay in interest?

Think of all the things you could have bought with that money.

Nobody thinks about this.

The Worst

But credit card debt is the worst. Of all the years I have had credit cards, only once did I carry a balance for a month. I was just curious to see what would happen. I got charged $50 in interest is what happened. Welp, that was fun.

There are people who carry tens of thousands of dollars (or more) in credit card debt. They pay the monthly minimum, incurring hundreds of dollars of interest charges every month.

I do not understand why someone would limp along under this crushing burden of debt and not take any action.

Bankruptcy is obviously an option, but a better option is to implement some austerity, start saving money and chip away at those credit card balances. You can get it to zero over time if you work at it.

Credit card debt should not be used at all. So if you have a balance, pay it off. If you have multiple balances, pay them all off. You should pay them off before you pay off your other debt because you are getting violated by the interest rate.

You have to take action. Leaving those bills unopened on the counter doesn’t mean this is all going to go away.

One Last Thing

The number one question I get as a financial writer—

--I mean the number one question—

“Why should I pay down my mortgage/car loan/credit cards? I can earn more than that in the stock market.”

Uh, no, you can’t.

Even if the after-tax interest rate for your mortgage is below 3%, there is no guarantee that you will be able to beat it.

All you will have done is swollen your balance sheet, with lots of assets and lots of liabilities. Shrink the balance sheet. Make it smaller.

It’s about safety. Once you own your house/car/life free and clear, there is no better feeling in the world.

The stock market may not behave. Then you’ll have debt and losses. Take care of the debt first—after that, start looking at making money in the stock market.

Freedom

Think of the thousands of dollars you have going out the door in debt service payments:

  • Mortgage
  • Car loan
  • Credit cards
  • Student loans

Some of this debt is “better” than others, but it’s all bad. Imagine you got rid of it all, and you had your income—all of it—turn into pure, free cash flow.

Is that even possible?

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DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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