Considerations for Paying Off Debt While Saving for Retirement
Debt can help us pay for a house, take your small business to the next level, or help you buy real estate investments, but you’ll want to be smart about how you use debt in your life.
Simply put, your retirement won’t be all rosy if you have to write huge checks to pay off your loans and mortgage each month. However, there are times when holding on to debt might be the smarter move, especially if you believe you can use the money loaned to increase returns in your business or investment holdings.
Keep reading to learn more about the role debt can play in your life, the benefits of keeping your debt, and how to decide whether it makes more sense to take advantage of a loan or pay off debt.
What Are the Benefits of Paying Off Debt?
A debt-free life can be quite calming.
Generally speaking, when you’ve paid off your debt, you’ll likely enjoy more financial security, and you’ll have a higher credit score. And you’ll have fewer bills to pay each month, too, which could mean a larger savings account.
Beyond that, paying off your debt means you’ll enjoy more ownership over your assets. Pay off your mortgage, and you may even end up owning your house outright. In addition to giving you peace of mind, a debt-free life also enables you to set a good example for your family, friends, and colleagues.
What Are the Benefits of Keeping Debt?
Although many of us have been conditioned to view debt as a bad word, borrowing money can actually be a good thing.
To give you a better idea of why you might want to hold on to some debt, here’s a couple vignettes to consider. Maybe you own a piece of investment property that has some debt, but it has significantly appreciated in value even with your loan. To increase your cash flow for your investment, you may want to execute a 1031 exchange and buy a more lucrative building and avoid capital gains tax, but a 1031 exchange requires you to keep the same amount of debt.
Or let’s say you’re a small business owner. You can see an opportunity to significantly increase the value of your business through investing in your business or acquiring a complementary company. This increased value from the investment or acquisition may go above and beyond the interest you’ll have to pay back to your lender. This, of course, is not guaranteed, but it could lead to increased wealth.
Finally, keeping debt can help you avoid a trap that many people run into: In an attempt to build more equity (e.g., in their house), some folks try to pay down their debt too fast—and find themselves becoming illiquid to the point where they need to file for bankruptcy. By maintaining appropriate debt levels for cash flow—and keeping all of your balances current—you may be able to maintain enough liquidity to live comfortably and avoid bankruptcy court.
How to Decide If You Should Pay Off Your Debt
Debt most likely plays a role in your wealth. You might have mortgages on real estate properties you either live in or use as investments, for example.
To determine whether you should start saving for retirement or pay off debt, the question is whether the interest you’re paying on the loans costs less than the money you could make by investing those funds elsewhere. If, for example, you have debt that’s accruing at 20 percent interest, you’ll probably want to eliminate that liability as quickly as possible. But if it’s accruing at only 2 percent, chances are that you may be able to find a better investment option for your situation.
As a good rule of thumb, target the highest-interest loans first. For example, you may want to figure out how to pay off credit card debt, how to pay off your mortgage quickly, how to pay down small-business loans, and how to pay off real estate investment loans. Once you’ve got to that point, consider paying off student loans for your kids.
Save for Retirement or Pay Off Debt: Some Final Thoughts
Believe it or not, the vast majority of Americans are in debt. And government bodies are in debt, too. So if you’re in debt, you’re not alone. But the key is to understand the role that debt plays in your finances.
Deciding whether or not to pay off your debt may be complicated, but you don’t have to go it on your own. EP Wealth can help. Contact an advisor today to find out more about how we can work together to develop a financial plan that helps you meet your long-term financial goals.
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