Deciding whether to invest or pay off debts can be challenging.
Here are some of your options:
Typically, the cost-effective option is to repay any debt with the highest interest rate first – before you start investing – as it’s charging you the most to borrow the money.
You should prioritise paying off any high interest credit cards and payday loans. That’s because the interest rate you pay is likely to be higher than the rate of return on any investment you make.
A sensible option would be to clear debt from overdrafts as quickly as you can – to reduce the amount of interest you pay and take control of your finances. If you find that you’re relying on your overdraft, it may not be the right time for you to invest.
We recommend that you build up an emergency fund of at least 3 months’ worth of living expenses before you consider investing. That way, you’d have some money available for the unexpected, without needing to dip into your investments.
Keep in mind – investing should be seen as a medium to long-term commitment, which means you should be prepared to invest for at least 5 years. This is to give your investments a chance to grow and ride out any short-term fluctuations in the market.
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If the returns you expect to make by investing are greater than the interest on your debt, could it make sense to invest instead of paying off your debts early? Maybe in theory. But investment returns are only expected – not guaranteed and you may not get back what you invest.
Here are a few factors to consider:
One thing that’s certain is your debt, whether interest-bearing or not, is a commitment that you need to be able to honour. Investing is the last thing you should do if it puts you at risk of not being able to pay off your debts.
A mortgage can be an exception to the ‘pay off your debts first’ rule.
Unlike short-term debts, mortgages are long-term commitments that have been priced to be paid off over the full term.
Also, delaying investing until your mortgage is repaid may limit your time in the investment market. And one of the strengths of investing over the long term is that it gives your money a chance to potentially grow.
Making overpayments on your mortgage could save you money on interest in the long run. However, not all mortgages are flexible. Before making overpayments, you should check the terms of your mortgage to see if they are allowed and, if so, whether there are any early repayment charges.
If your mortgage won’t let you make overpayments or limits them to 10% a year, it could make sense to put any extra money into an investment. That way, you’d be building up a separate pot of money, alongside the value in your property, to help improve your financial future.
Keep in mind – investing comes with risk, and you could get back less than you put in.
