Pay Down Debt or Save?

This is a dilemma that many Americans face: Is it better to pay off debt or to save and invest? A recent article from 360 Degrees of Financial Literacy outlines some strategies that you might want to consider as you ponder this question.

The most common factor used to decide where to pay off debt or make investments is to determine if you could earn a higher after- tax rate of return on the investments than the after- tax interest rate on the debt if you were to invest your money instead of using it to pay down debt.

Here is an example provided by 360 Degrees of Financial Literacy. If you have a credit card with a balance of $10,000 and a nondeductible interest of 18%, you would generally need to earn an after-tax rate of return greater than 18% to consider making an investment rather than paying off the debt.

It is important to remember that it isn’t always an all- or- nothing choice. Another strategy that is useful is to pay off debts with high interest rates first. Then, invest when you have an opportunity to make investments that may earn a higher after- tax rate of return than the after- tax interest rate on your remaining debts.

For example, say your tax rate is 28% and you have a credit card with a balance of $10,00 and a nondeductible interest rate of 18% as well as a mortgage with a balance of $10,000 and a deductible interest rate of 6%. If you have $20,000 available to invest or pay off debt, you should pay off the credit card first and invest the remaining $10,000.

It is also important to remember that when you are investing, the higher the rate of return generally means the greater the risk. So if your investments incur losses, you may still have debt to pay.

Click here to read the full article and for a more comprehensive list of things you should consider when you are deciding whether to pay down debt or save and invest.