Sometime ago, I uploaded a video that explains my unique debt repayment strategy – after all, EVERY self-respecting ‘finance guru’ has one these days 😛 – and, I wrote a follow-up post explaining the concept of ‘expensive debt v cheap debt.
Money Funk – and, I thank her for (a) taking the time to run the numbers, and (b) for taking the trouble to write about what she found (in not just one post, but two on her own blog) – says:
Now, read the post and reread the post. It took me a couple times to completely follow. But, I will tell you that I am really glad I did. Why? Well, because it could end up saving me $35,328!
I recommend that you read Money Funk’s post – “and reread the post” – to see how she thought through the numbers …
… but, for those of you – like me – whose eyes glaze over as soon as you see a bunch of numbers with IF’s and THEN’s liberally interspersed, simply think about the whole subject this way:
Take a look at the interest rate on the debt that you are thinking of paying (e.g. 2.5% on a student loan; 5.5% on a mortgage / housing loan; 19% on a credit card debt) and decide whether you would be better off leaving that loan in place and investing the payments that you would have made instead.
– If you could earn 8.5% on that money in the stock market, why wouldn’t you do that?? 8.5% is better than either 2.5% or 5.5%
– Alternatively, if you are thinking of borrowing to buy an investment property, why would you pay off a 2.5% loan just to then take out a 6.5% ‘investment loan’?
Oh, and if you are not thinking of buying an investment property instead of paying down any reasonable, low-cost (eg mortgage or student loan) debt … think again!
– However, if you are carrying a 19% credit card debt, what are you thinking of: pay that sucker off ASAP!
BTW: you may be wondering what the Debt-to-Income-Ratio pie chart on the top of the page has to do with anything?
I ‘lifted’ it off MoneyFunk’s site before she changed the pie chart to this one:
Now, I can’t comment on the first version, but I can on this one: even though Motley Fool suggests that it’s OK to carry 15% of your income in servicing ‘bad debt’, the ‘correct’ ratio of bad debt to income is 0% … you should carry NO bad debt.
On the other hand, if you DO currently have ‘bad debt’ (eg consumer loans, car loans, mortgage – this one is in the ‘grey area’ between good/bad debt – or credit cards) then the correct comparison is how much expensive debt you should carry v cheap debt … the answer again, of course, is none.
So, the real comparison is how much cheap debt you should then carry, but that’s a whole other enchilada that I have some of my best people working on for you …
… stay tuned 😉
This is like the closing credits: the reward for people who don’t leave the movie until the VERY end … or, in this case, actually for people who read the WHOLE post: