I have long flouted the “rules” of personal finance blogging, since I’ve been a staunch believer that it’s not always necessary to pay off debt as quickly as possible. This is a stance that has earned my sideways glances over the years. However, it’s one that I’m comfortable with, and it’s an approach that I don’t intend to change anytime soon.
There’s No Reason to Accelerate Repayment on Low-Interest, Tax-Deductible Debt
Just because I’m willing to carry some debt doesn’t mean I’m comfortable with all debt. I don’t advocate running up balances on credit cards with high-interest rates and only paying the minimum for years and years. The kind of debt I’m willing to keep around for 25 or 30 years is the low-interest, tax-deductible variety.
Back when I had a mortgage, I had no intention of paying it off early. After I refinanced to a low-interest rate (and a 30-year term), I was able to free up $300 extra dollars a month. That’s money that I could invest. Over the last 10 years, my annualized returns on my investments have been right around six to seven percent. I’d rather put that extra $300 a month to work earning interest than paying off a loan with an interest rate of less than four percent. Plus, mortgage interest is tax deductible when you itemize (and I do). That means that the money is even cheaper. Put that extra $300 in a tax-advantaged account, like my HSA or an employer-sponsored plan, and it’s even more efficient.
I follow this same logic when I keep paying on my student loans. Because of when I consolidated my federal loans, my interest rate is less than two percent, and it’s tax-deductible. As you can see, there isn’t much call for me to pay off my student loans early. Paying off my student debt early means a “guaranteed return” of less than two percent annually. I can do much better by maintaining my student loan payments and investing the money I would have used.
Low-Interest Consumer Debt
My interest toward not paying of low-interest, tax-deductible debt is at least somewhat defensible. Where many people really have a problem is with the idea that I am willing to carry low-interest consumer debt as well. For example, a little more than three years ago I bought a car using a loan. Rather than just buy the car with cash I had already saved, I financed most of the cost of the car. The interest rate is less than two percent, so I don’t really feel bad about it. I’m willing to pay for financing a car for five years at less than two percent, even without the tax deduction, because, again, I can invest the money.
Rather than save up to buy cars in a low-rate environment, I invested our money and then finance our cars at low rates. It works right now. As interest rates rise, we will have to revisit the current policy. But, by then, the money we have invested will have grown enough that we will be able to use bigger down payments or pay entirely in cash. The fact that we tend to keep our cars for seven to 10 years also helps us make the most of the way we do things.
In the end, it’s about what the money can do for me, and where it is likely to provide me the biggest bang for my buck. Often, tackling low-interest debt isn’t the most efficient use of my financial resources.
The only thing that sometimes gives me pause is the idea that we could get “stuck” in the event of a financial catastrophe. What happens if my husband loses his job, or if a major client of mine goes out of business? We try to make sure that, even with these types of setbacks, we would still be able to meet our obligations. As a result, we don’t get huge loans, and we make sure that monthly payments are manageable — and that we keep the emergency fund well stocked.
What are your thoughts on debt and paying it off early?