I consider this one of the age old questions.
As young workers starting out we are faced with many different challenges. Faced with paying off credit card debts, saving for a house, retirement, a new car and the list goes on. This was from a question I received the other day.
Should I pay off my student loans or save for retirement?
Without doing one you can’t achieve the other. But when you are young the best thing to do is start saving for retirement because of a little thing called compounding interest.
Though, there are a couple of ways to dissect this question. The first questions to be answered are; how high is the interest rate on the debt and what type of debt is it? There can be a big difference in trying to pay down a big balance on a credit card with a 12% interest rate then a 4% interest mortgage.
Deciding to pay down debt is not a simple yes or no answer. There can be variables that play into your decision on how fast or how long to take to pay it off. Although no one enjoys acquiring debt, it can provide leverage for appreciating assets. Here are a couple quick rules in terms of the types of debt you may have and hopefully it will help to answer the above:
Credit Card Debt
It should be paid down to zero each month, but if you have a big balance, look to do a balance transfer to a 0% interest card, this way it will make payments easier to manage. Once you have paid it off, don’t let it happen again!
A little trickier. I know some student loans could be considered mortgages in some places. In that case it pay be extremely hard to pay down this debt, and if it will take longer than say 3 years to pay down with aggressive payments it may be wiser to save for other items such as a house down payment or retirement. Accommodating this into your budget for a reasonable payoff date would be the smart thing due to the usually high balances student loans are.
A different story. Depending on your interest rate, there may be no rush to pay down and acquire your house outright. Said another way why would you pay down debt at 4% if you can make a higher return than 4% saving or investing that money?
Make sure the monthly payment isn’t making you poor. Work to try and pay a big down payment when you initially purchase the car that is if you don’t have the cash on hand. Remember most cars are depreciating assets, so this is another debt you don’t want to be making a major dent in your budget.
Lastly, be smart. You have to be realistic and know what your money personality is. I for one am a total saver. I would rather save than spend. But if you are more of a spender it may be better to pay down the debt faster. Debt is not something to be attached to. A rule of thumb is keeping your total debt to less than 36% of your gross income. There are good debts, but those are limited to appreciating assets.
If you have a long time to build assets for retirement, it may work to kill off your debt quickly so as to begin saving right away. You shouldn’t kill yourself paying down debt. Although, debt can cause certain people to cringe, by leveraging your biggest resource, time, it may not be beneficial to put extra money towards your debt, especially student loans.