Should I pay off my debt?
Or make the monthly payments?
I’ve been asked this question a few times, but it’s not that simple there are a lot of factors to consider before making a big payment to crush that debt.
- Cash flow = debt service. Does your monthly income passive (preferably), and or active easily cover your debts, and is the debt helping your business grow? If you have a loan of $500 a month and you have a dividend portfolio that pays out that amount or more every month, then you might not want to pay it off. Because the debt is passively serviceable. If you can make an extra $1,000 a month or X amount by taking out a business loan or mortgage to grow your business, and you can service it through your business revenues then it may be a good idea to take on that debt.
- The amount. Is it just a small loan for $5,000 or is it a half million dollar mortgage or business loan. A small loan may be just an annoyance to you every month. A few grand on a credit card or even a small HELOC loan. You might just want to get rid of it as a convenience factor.
- Is the debt able to be written off on your taxes. Student loans, mortgages, certain business loans may be able to be written off on your income tax, to lower your overall tax burden. The amount might not be that much in the case of student loans, however there may be important deductions that you’re able to receive on your taxes. You have to consider, does the tax benefit outweigh the payments? Talk to your tax preparer.
- What is the interest rate of the debt vs. your cash/investment account. If your debt interest rate is lower than what your investment accounts are making and back to the first point, its serviceable, then don’t worry about it. If your debt is extremely high like a 25% credit card, then yes you must pay that off immediately. Another good example is if your loan on a rental property comes to $1000 total every month, but your rental income is more than that, then obviously just let the debt be serviced. There is an advanced strategy where you will have the inverse, called Negative Gearing. This is where your mortgage is higher than your rents but you will be holding onto the house for a short period of time and sell for appreciation, while also helping to limit your taxable income. Always consult a tax professional.
- What is the amount of your cash reserve. Are you going to deplete a big chunk of your cash reserve to pay off this debt, you’ll have the convenience of no debt but what if something comes up in your business or personal life where you need cash and don’t have it. It may not be worth it to pay off the debt. If you pay an extra $5,000 on a $100,000 loan, what’s the point? It won’t make a difference. Do be so anxious to pay off the debt. You always need a cash reserve for emergency situations.
These are the points I consider when paying off a loan. I have made mistakes before and have been cash poor. When you consider these 5 points before paying off debt you can be sure not to make the same past mistakes I have. Think logical about it and don’t get too emotional or excited to be debt free. It’s a good feeling not to have debt, but at what expense.