Pay off debt first or invest?
The process of cash or income generation is rather complex and given that there essentially an infinite number of ways to earn some extra money, it can be quite difficult to know what path to take.
For a lot of people, there are often two choices and that is to either pay off their existing debts as a means to save money through reducing interest charges, or there’s the option to invest rather than pay off debt as a way to generate cash through capital growth.
If you’re a little stuck between these two options, then we have some tips and a little direction for you below, though, keep in mind that both of these methods are great to consider, though depending on your circumstances, one may be better than the other.
Save or pay off debt
Before we dive into paying off debt or investing, it is important to work out whether it is best for you to pay off debt or save money.
Though this might seem like a no-brainer, in some cases debt might not be costing you as much as you think, so it’s always a good idea to crunch the numbers and see what your finances are looking like.
If you find that your debt’s interest rate is rather low, and your potential savings account interest rate is a lot higher, then it makes sense to simply keep on top of saving and pay off your debts as you normally would. This gives you the chance to earn some extra money whilst also keeping the cost of your debt to a minimum.
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Key reasons to invest
As we mentioned above, if you have noticed that your debts aren’t all that expensive, and you can earn a lot more through investing than paying off your debts early, then investing is certainly the way to go.
In a lot of cases, you can determine with a reasonable level of accuracy just how much your investments are going to make by taking a look at the expected performance of a stock or investment, and also the previous growth. A lot of funds out there see annual growth between 5 and 10 per cent, and this is often a little more than some debts – though not credit card debt.
We know that all stocks, for example, can become quite volatile as we saw during the pandemic, though in most cases, you will be able to rely on slow and steady growth. However, investing in a single stock may present a little more risk, and so looking to funds like ETFs might be the best way to go here. As a beginner you can use something like ChipX to invest in a huge range of funds via Blackrock with ease.
With those points in mind, it is still important to do plenty of research into the expected growth of stocks and compare this percentage point to the cost of your debt, and you’ll have a little more understanding of how well things might fare for you.
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The importance of your credit score
Pivoting back to paying off debt, there are also some underlying factors that might be worth considering, and one of those is your credit score.
If you’re looking to invest in a property in the near future, or purchase a car, for example, you’re going to want to make sure you have the power to invest or borrow as much as possible, and this will rely heavily on your credit score, and with that, a low level of debt!
For our readers looking into paying down debt or investing in property, vehicles or anything else in the future that requires you to borrow some cash, then paying down debt has no match.
You are almost always going to want to make yourself look good to the big banks, and with a credit score that is great, you’re going to be in the clear for future investments.
One final thing to keep a note of is that credit scores are often founded upon your utilisation of the credit that you have available to you. For example, if you have a £5,000 credit limit, and you’re actively using around £4,500 and not regularly paying it down to £0 or a reasonable level, your credit score is going to be negatively affected, and so keeping on top of this credit minimisation above investing is something to consider.
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How to pay off debt quickly
For our readers looking to get on top of their debt as fast as possible, we have some quick tips here for you that might make the process a little bit quicker. And from here, you’ll be able to move on to investing with little worry about your debts.
- To start, pay off higher interest debts before anything else.
- As an example, if you have three credit cards, at rates of 20%, 15% and 10% start off with the highest rate even if it has a lower utilisation.
- A £2,000 debt on a 10% credit card can wait until the £1,000 debt on the 20% card is paid off, for example – and then move down the ladder to the 15% card and then the 10%.
- If you can, switch to a 0% balance transfer credit card to give yourself a break from the interest and try to clear as much of the credit as possible during the 0% period. Just be aware of any upfront fees for making a balance transfer and whether these will be less than the interest you pay on your existing card.
Added to this, it might also be worth cutting every day’s expenses down to wipe out your debt as soon as possible. Your bank and credit score will thank you for this and you’re going to have reduced stress too, given that you’re better able to freely spend without the worry of adding more debt to your cards.
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Invest and pay off debt
To end our article, there might be a case for both investing and paying off debt at the same time, though this may require a little restructuring of your daily expenses.
Of course, when paying off debt and investing in the market at the same time, you’re going to need a little more cash on hand, so cutting back on those non-essentials until you’re in the green is a good place to start.
You may also want to consider investing in a mutual fund here as these are a little more accessible to you should you need to withdraw cash for an emergency. In some cases, these also grow with a little less volatility than other stocks.