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Does it make sense to pay off debt vs. further savings.

My husband are pretty ok financially today. We are currently able to save $2500 a month but we have 4 outstanding debt payments: my student loan, his car,1 rental property mortgage, and our home mortgage. We figure that by paying $500 a month on debt, we could free up more money to pay off all debt in 10 years. We can still save $2,000 a month. This is assuming that everything remains as is today. Is there a risk or downside to doing this? We are 30 years old.

Note: we also put 6% into employer matched 401k and have long-term life insurance.

Jan 07, 2014 by Brenda from Chester Springs, PA in  |  Flag
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Rich Winer Level 20

Brenda, It looks like you are doing a good job of saving and doing the right things to build wealth. One key issue to consider is the rate of interest you are paying on your debt versus how much you could earn on your investments with a comfortable amount of risk. If your loans are at low rates of interest and/or tax deductible, then it might make sense not to pay them down ahead of schedule. If you are paying 4% on your debt and can earn 6% or more on your investments, then you come out ahead. However, if you are paying more than 6% or more, then you might want to consider paying down some of your debt. If you do, your car loan (which I'm guessing might be the highest rate) might be a good place to start. Keep up the good work.

Comment   |  Flag   |  Jan 07, 2014 from Woodland Hills, CA

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Joe Day, CFA Level 13

Saving vs paying off debt is always a delicate balance. The first thing to consider is what rate of interest are you paying on your student loan, car, and mortgages. If you make the decision to pay down debt vs save more, always be sure to pay the highest interest loans first.

Second, remember that you usually have a tax deduction that accompanies your mortgage interest on your primary qualified home (sometimes on your rental property home, if you live in it part of the year and it meets the IRS definition of a "qualified" home). Depending on your incomes this can help offset taxes enough to really lower the overall cost of borrowing.

Regarding your savings, if you are merely putting the $2500 into a money market, it may make more sense to pay down more debt. As you will surely be paying more in interest then you'll be earning in a money market fund, at todays rates. If you are investing the funds in a well-balanced diversified long-term portfolio, then continuing to save may be the better option. It depends on what you will have to pay in interest vs. what you can earn invested in the market over the long-term. This would require you to make some assumptions on what you could earn and that would depend on how aggressive or conservative you are with your portfolio.

To know whether you should pay down debt more or save more, would require a more in depth understanding of your financial situation, including understanding your long-term goals/objectives, with a better picture of your current financial assets. Debt can be a useful tool, just ensure that its not over used. Keep your interest rates low and pay off high rate, non-deductible debt first. In the end, if you and your husband would sleep easier with less debt than you probably should work toward that goal.

Comment   |  Flag   |  Jan 07, 2014 from Seattle, WA

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Hi Brenda! Sounds like you are on the right track. Rich and Joe have given you good info, so I'll add something different. I'm always a big fan of paying off debt as soon as possible. There is an intangible positive feeling to being debt free that cannot be summed up by a dollar value, even though you will likely be ahead mathematically. Assuming you have an adequate emergency fund built up, suppose you focus your extra funds on paying off the car first. Then, maybe the student loan. Then you could work on the rental, saving the home mortgage for last to preserve that tax deduction as long as possible. Sometimes it is better to focus on quickly paying off one item at a time rather than spreading payments around across several debts.

Just some suggestions to think about as you work on paying off your debt. Good luck to you!

Comment   |  Flag   |  Jan 08, 2014 from River Hills, SC

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I would add a couple of other thoughts. 1. Make sure you have cash for emergencies set aside before you start paying off debt. If your jobs and income are safe and stable, then enough to pay about 3 months expenses should be sufficient. 2. As others have stated, consider the interest rates, but also the impact of tax benefits. For example, if you itemize taxes, you are deducting your mortgage interest. If you are in a 30% tax bracket (state and fed), that means that after considering tax savings your 4% mortgage is really a 2.8% loan. Likewise, depending on your income, you may be deducting at least part of your student loan interest. I agree with Pam on paying the car for sure - unless it was one of those ultra low cost 0% or 1.9% loans.

So higher taxes would offset the benefit you receive from paying down your mortgage, and maybe the same for your student loan. In contrast, increasing your 401k contribution will decrease your taxes. So again if you are in the 30% bracket, then every dollar you put into the 401k really only costs you 70 cents. The government has created a pretty strong incentive to put money into your 401k rather than paying down your mortgage (and maybe your student loan). .

Comment   |  Flag   |  Jan 08, 2014 from Bridgewater, NJ

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