Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Consumer Debt is debt that is taken on to pay for consumption. Typical examples include credit card debt, personal loans, and auto loans. The debt vehicles are all usually used to purchase things that lose value as time goes by. These loans usually have a relatively short duration, higher cost (interest rate, expenses, etc.), and may or may not have a fixed interest rate.

Investment Debt is used to pay for things that increase in value over time, or things that improve income potential. Examples include mortgages, student loans, and business loans. These loans are generally longer term with fixed interest rates for a certain period of time and clearly defined times and circumstances for changes in loan terms.

I currently carry only one example of consumer debt in the form of a car loan. All the rest of my debt is investment debt: student loan, mortgages, and credit card debt that was used to pay for home improvements. All of my debt, consumer or investment, has an interest rate of less than 6.625%. My consumer and credit debt is all less than 5.5%

I have been working hard to pay down my low interest debt. I have been paying far more than the minimum on my car loan for some time now, and plan to finish paying for it in just over a year. In the mean time I will be making some progress on my other debts as well. Once the car loan has been paid off, I plan to put all that money towards my other debts in classic snowball fashion.

When I am done paying for all of that debt, my plan was to start a new car fund, increase my emergency fund, save for a down payment on a single family home, and put anything left in long term investments. Some people might suggest that I use some of the money to pay down my mortgages early. Being mathematically minded, I have often felt that the best course of action is not to pay down a mortgage early, but instead to take the money that I would be putting into paying down the mortgage and instead put it into a stock market index fund. Since the market, on average, earns more than the interest on my mortgage by almost 2 to 1, my money will work a lot harder in the stock market than it will by “investing” in a low interest mortgage.

Lately I have been considering taking this idea one step further: I wonder if I should slow down my debt paydown and take the extra money and put it towards investments that will earn higher returns. Instead of paying $1600 per month towards my car loan, for example, I could instead put $1100 towards the car loan and $500 into a stock index fund. The car loan costs me 5.5%, but the market (in time) should return closer to 10%. The car will get paid for a little slower, and I’ll be that much closer to my savings goal of 20%. Clearly I could extend this even further and reduce my aggressive debt paydown even further.

On the flip side, once I have my “small debts” paid off, I’ll be in a more secure financial position because I won’t have to worry about paying them if my income should dry up for some reason (layoff, extended illness, etc.).

So the question is: Does it make sense to slow down the payoff of a mix of Consumer and Investment debt, all at relatively low rates, in order to increase my savings rate, which should over time result in much higher returns than the interest payments on the debts? What do you think and what would you do in my situation?

If you liked this article, you may be interested in seeing some related articles:


10 Responses to “Invest or pay down low interest debt?”


  1. Matt Says:

    People are often afraid of debt, but I’m in your camp. Debt can be a good thing, especially mortgage debt. I agree with your mortgage vs. stock market argument. It never feels good when markets are going down like they have been recently, but over the long run, you can’t go wrong by borrowing against your house. The IRS is practically twisting your arm to do so! My after-tax equivalent mortgage rate is below 3% and even my two-year-old daughter could figure out a way to earn that back over time. As for cars, we also have car loans because they are typically relatively low rates as they are also collateralized. Since you are young and have 30 years of income ahead of you, I strongly favor carrying low-interest debt like a primary mortgage and auto loan, and investing in the stock market instead of paying it down, as long as your income alone can support the debt interest payments.


  2. MITBeta Says:

    If she can figure out how to earn (rate of inflation)+3% I’ll let her manage my portfolio!


  3. Matt Says:

    Don’t underestimate her. I’m teaching her already. She’s not up to earning a 3% real return yet, but she can definitely earn enough to cover the mortgage.


  4. Steve Says:

    I’m in a similar situation (student loans, car loan, etc.) with a maximum interest rate of 4.9%, but not yet a homeowner. Taking Suze Orman’s advice, I’ve chosen to invest with my excess rather than pay down the low interest-rate debt…with one exception: Because I hold credit card debt, though at a low interest rate, I continue to make modestly inflated payments to decrease the debt. I do this because when it’s time to buy a home, my debt-to-credit ratio will affect the mortgage interest rate. So I lose out on the investment interest, but gain with a lower interest rate mortgage. As a small-scale landlord, this might be a consideration for your next home purchase. Unless you have stellar credit already, in which case it’s mathematically sound to slow down the debt-repayment and invest.

    On the flipside, like you suggested, the security of having less/no debt should be a very satisfying financial freedom. It’s a bit of tug-o-war, no?


  5. MITBeta Says:

    Steve:

    I should have all of my low interest debt paid off well in advance of the need for new credit. Even if this were not the case, ScrapperMom and I still have excellent credit. Our debts are a very small portion of our total credit at this point.

    I also agree that the credit card debt bothers me more than the car loan debt (I’m not sure why…), but it has the lower effective interest rate, so it will get paid last.

    Thanks for the comment.


  6. Matt Says:

    I also feel bothered about credit card debt but not car loans. I guess car loans are acceptable and almost the standard these days, but carrying credit card debt is viewed as irresponsible and a means for overextending and living beyond your means, even if that’s not always the case.

    Since you brought up long-term investments and real rates of return, an interesting and relevant topic for a future entry might be how to structure one’s investments in today’s challenging times of a depreciating dollar, rising inflation, falling real estate and seemingly low expected future real rates of return. How do we all invest for the short-term, medium-term and long-term and is it actually the right time to be seeking leverage or playing it safe?


  7. MITBeta Says:

    Matt:

    Interesting point on the car loans, and interesting question on investing for the current market. I started to write a response to the car loan point, but it turned into a whole post. Look for it soon along with a response to your question.


Trackbacks

  1. Don’t Feed the Alligators » Blog Archive » Whither the Stigma on Car Loans?
  2. Don’t Feed the Alligators » Blog Archive » Invest or pay down low interest debt? Redux
  3. Don’t Feed the Alligators » Blog Archive » Financial Independence Day