People ask often which is better to pay off debt, but the answer is often not obvious.
Which one will pay down debt the fastest totally depends on the interest rate you're paying on the loan, the growth rate you expect on your investment, and the length of time either may take. But here are some things to consider before deciding which is the best pay down debt strategy for you, especially if the numbers don't reveal an obvious decision on how to lower debt ...
Many banks are more likely to foreclose on a loan with a lower balance. You read that right - LOWER balance. That's because it lowers their chance of taking a loss since they can usually only keep what you owe on the loan no matter the value of the property foreclosed. It's a whole lot easier and quicker to sell a probably well below it's actual value.
An investment can act as an emergency fund. You can get money from an investment if you lose your job or have unexpected large medical, home or car repair expenses. Once it's paid on a loan, you can't get that back for emergencies.
Neither pay off debt strategy fits everyone's circumstances. Run the numbers, consider the length of time involved and the risk of being able to carry your pay down debt strategy to the end of the loan, then decide how to lower debt that fits your circumstances best.
TitleA title for these calculator results that will help you identify it if you have printed out several versions of the calculator.
Additional Monthly AmountThe amount, in addition to your Debt Monthly Payment amount, you can pay each month toward your debt or investment.
Cash On HandAny cash you have available to be used as a lump sum payment toward your debt or as a lump sum deposit into your investment.
Federal Tax RateThe percentage of federal taxes you pay.
State Tax RateThe percentage of state taxes you pay.
Debt BalanceThe current total balance of your debts.
Interest RateThe interest rate (or average rate if there are multiple debts included in Debt Balance) you are paying on the debt.
Monthly PaymentThe principal and interest portion of each monthly payment. This may not be the amount you write a check for each month. Depending on the type of loan, your actual payment may include other amounts for escrow, private mortgage insurance (PMI), fees, or property taxes.
Tax Deductible InterestThis box should be checked if the interest you are paying is tax deductible.
Starting BalanceIf you already have an investment plan that you will continue putting the additional money into, enter the balance here as a starting point.
Anticipated Rate of ReturnThe rate you anticipate your investment will earn each year.
Taxable ReturnsThis box should be checked if the investment earnings are reported on your yearly taxes.
Invest Full Length
(column)You will make minimum payments on the debt and additional money will be invested for the entire length of the debt. No money will be withdrawn from the investment even when the investment can pay pay off the debt.
Invest Extra to Pay Debt
(column)You will make minimum payments on the debt and additional money will be invested. Money will be withdrawn from the investment to pay off the debt as soon as the value in the investment is more than the debt balance.
Invest After Debt Paid
(column)All money will pay the debt until it is paid off, then all money will be invested.
Debt Payoff TimeThe number of years and months to pay off the debt using each strategy.
Effective After Tax ValueThe effective value of the investment at the end of the debt term. This may not be the actual value of your investment as shown on a statement. For comparison purposes and determining which strategy is best, this value has been adjusted for tax savings due to tax deductible debt interest and taxes paid on investment earnings.
RecommendationThe recommended strategy always has the highest 'Effective After Tax Value', which is the investment value with tax savings added and taxes paid subtracted.
Total InterestTotal amount of interest you will pay on the 'Debt Balance'.
Total PaidTotal amount of principal ('Debt Balance') + interest you will pay while paying off the debt.
Tax SavingsYou will save this amount in taxes if the debt interest is tax deductible.
Effective Total Paid'Total Paid' minus 'Tax Savings' is effectively what the debt will cost you.
Invested TimeThe number of years and months you will add money to your investment. Some strategies invest the entire time it takes to pay the debt.
Total InvestedThe total money added to your investment over 'Invested Time'.
Value IncreaseAlso known as Return on Investment. Given the 'Anticipated Rate of Return', your investment will earn this amount during the time it takes to pay off the debt.
Total ValueThe investment value when the debt is paid. 'Starting Balance', 'Total Invested', and 'Value Increase' are included so the amount on an investment statement should be the same as this amount, assuming you did not withdraw money from the investment to pay taxes.
Taxes PaidThe amount you will pay in taxes on the 'Value Increase' amount.
Effective End ValueThe investment's 'Total Value' minus 'Taxes Paid' reflects the true value of your investment for comparison purposes. The actual balance of your investment as shown on a statement will probably be higher since it is assumed you did not withdraw money from the investment to pay taxes.