Last week at work I was having a conversation with a few of my colleagues about spending money now vs spending money later. My view was that if you have debt you should be spending the majority of your disposable income into paying off your debt ahead of time. Obviously there are a lot of factors to consider before making that call, but for my situation I feel like paying off debt early is the best course of action so that I can achieve some of my long term financial goals.
Why I think paying off Debt faster is the right move
My wife and I got married and purchased a house at quite a young age, when we weren’t really earning a lot of money. In hindsight, deciding to buy a house at the peak of the market probably wasn’t the best move that we could have made, but it has turned out fairly well for us and I am not sure I would change it if I was given the chance. Anyway, after only a few months of having to pay a ridiculous amount of interest (interest rates were above 9% PA at the time) and not getting ahead on our home loan, we decided to get smart about our debt and try our best to pay it off ASAP.
We jumped onto an online mortgage calculator and worked out that if we continued to just pay the minimum repayments that we would end up paying around $600,000 in just interest repayments. That is nearly 200% of the cost of the house and it was an insane amount of money. We took a look at our budget and tracked our spending and worked out that if we really tightened our belts we could probably pay off the loan in about 13 years and save ourselves $400,000 in interest repayments.
Fortunately for us the GFC hit and reduced interest rates to about 5% and we moved from paying off the loan in 13 years to about 7-8 years. This in turn meant that we were saving heaps on interest over the life of the loan and could put that extra money into even more extra repayments. If I was in the US or Japan where interest rates are almost 0% then I probably wouldn’t have done this, but you have to play the hand you are dealt I guess.
By the time we finally pay off our loan, I expect that we will have saved somewhere in the area of $350,000 to $450,000 (it is difficult to say with the wild swings in interest rates). In my mind I am happy to forgo a few of life’s little luxuries so that by the time I am in my early 30’s I will own my own home and be ahead about $400,000 in interest to the bank. What I feel many people forget is that by saving on all this interest at such a young age, we will now have the next 30-40 years of not being $400,000 behind the 8 ball. This means that each year we are out of debt and saving, we get to compound whatever we have saved from the year before and by the time we are in our mid to late 40’s we will have more money than what most people retire with. This in turn enables us to retire significantly earlier than the average Joe.
Another benefit that we have with our current level of debt is that our minimum repayment on our mortgage is down to $141 a week. This means that we are afforded the opportunity for my wife to not have to go back to work (if she doesn’t want to) once her maternity leave is over. Plus I also take a 15% pay cut to enjoy the benefits of rostered days off once a fortnight. If we hadn’t paid off our debt so aggressively then there is almost no way either of these scenarios could have happened.
My view on it all is that if you like working for the man for the rest of your life then go right ahead. But if you like spending time with your family away from the pressures of work, then start getting smart about managing your money and in particular debt management.
What would you do?
I am interested in what you would do in my situation? Do you think that paying off debt as early as my wife and I have is a worthwhile exercise? Or should you live it up now and pay off the debt when you get the chance?
I think it depends on the debt and the interest rate. I also think it depends how much you have in your savings account. If I only keep $300 in my savings account and pay an extra $1k on my mortgage, I’m in trouble if I hit hard times and lose my regular income for a few months.
I totally agree! If your interest is lower and you can put away money for savings, then yes, otherwise, I would do it in moderation.
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I would pay it off now. You never know what will happen years from now that might make it more difficult to pay it off.
Holly@ClubThrifty recently posted..Political Correctness in the Workplace
I’m with Holly – get rid of the debt ASAP! Even if you don’t think disaster is going to mess up your finances, you just never know what kind of opportunities might arise in the future, either, that you would have to pass up due to carrying a heavy debtload. Don’t lock yourself into a job because you need the money. Pay off the debt and have to freedom to make life choices based on what’s right for you instead of what will pay the bills.
I think there are benefits to both sides of this argument and to solve it you need to know the one piece of info that’s unknowable: how long are you going to live? Because I’m betting on living a long time I love the idea of paying off debt quickly.
Yes at this kind of rate I would do my best to pay debt early. Boy I wouldn’t sleep thinking about the interest rate haha! My mortgage is 2.29% on a cash flow positive rental, so i won’t repay anytime soon.
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I am with DC on this one. I think it really depends on the debt and how much the rate is. If you can use your money to make more than what the rate is on your other debt, than technically that is a better choice. The other issue comes down to personal feelings. You have to do what makes you feel good an what makes you sleep at night. Just like how I liked to save and pay down debt. It is not mathematically correct, but it was what made me feel better.
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Like most things in life, I think balance is the key. Living like a pauper for a many years while all of your money is funneled into debt pay off is probably too extreme. But then so is making only the minimum payments on high-interest debts while taking annual month-long trips to the Caribbean. I don’t like paying interest, so we struck a balance more toward the debt payoff end of the spectrum. We enjoy simple (i.e., inexpensive) pleasures, so we felt we were sacrificing little. Our reward is debt freedom, which is huge for us.
It sounds like you found a good plan that works for you. I’d would have certainly prioritized the mortgage given the interest rates you were paying (9% – ouch!) I’m a big believer in paying down debt, but I like to see it balanced with saving too (even if it’s just a small amount). Your plan has already given you some extra wiggle room and freedom that is way more valuable to you than “stuff” you would’ve bought with the money instead.
I think it comes down to the amount and the rate you’re paying on it. I tend to say pay it off as soon as you can, but life is not always cut and dry like that.
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I believe that it could be a good thing to pay off the debt if you have sufficient savings for a rainy day. No need to pay off 10k and be broke then something happens and you have no funds at all. With the home I agree with paying it off earlier if you have a high interest rates and you don’t have other things that allow that money to make you more money. if you can get 10% return on 100k an are only paying 3.5% on a mortgage I would go with putting the money where it can and would work for you.
I also agree with DC – it depends on the type and the interest rate. In your situation, I would probably be doing my best to pay it off sooner than later! As long as you are happy with your plan and your progress thus far that’s all that matters – that it works for you. I do think that it is important to step back and re-evaluate things every once in a while, as situations change.
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I think Ross Gittin’s has a formula – when you get close to paying off your house, you should only pay $12 per remaining $1k on the mortage, to make the most of the interest rate being low or something. I’ll see if I can find the reference and send it to you.
That weekly payment is awesomely small – good on you!
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You can certainly look at interest rates and other ways you could invest money that you are not paying toward debt, but I know you would like to be home more with your son. I’d say pay it off as fast as you can and you will have many more options about how much or how little you want to work at a corporate job.
Pay it off! I am accelerating my mortgage payment and if anything if I decided to sell I would at least get that money back. As long as you’re paying off other debts and saving/investing than I don’t think there is a problem with paying your mortgage off in 7 or 8 years. Think of all the investing money you’ll have. Nice.
Paying of debt first in most circumstances is the right thing to do. If the debt is not secured debt then pay it off straight away. This will ensure you save money on interest and don’t have liabilities hanging over your head.
However, I also think its necessary to point out that debt for business or investment properties can save you money on tax. So in these instances you need to consider the pros and cons of paying the debt off early.
Debt does have the ability to control your life if not used appropriately.
Cheers
Rusty
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If it is personal or unsecured debt then pay it off. Having this type of debt will hold you back. If however, it is business debt or debt for an investment property, it may offer some tax advantages. Looking at the bigger picture will help you make the right decision.
Rusty