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The Great Debate – Pay Down Debt or Save?

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The debate rages on! Is it wiser to pay down debt or save for the future? If you ask a dozen financial planners, chances are good that you’ll receive a variety of answers. Since you’re asking us, though, here’s our take: it depends. Let’s start the discussion with an important caveat. If the situation in question entails large amounts of consumer debt, like credit cards or high interest loans, we often encourage professional debt counseling as a first step. In Colorado, one of our primary sources for such services is mpowered, an organization whose expertise includes individual financial coaching, debt management plans, credit check-ups, bankruptcy counseling, and personal finance classes.

With clients who come to us carrying lower amounts of debt, including credit cards, loans, and mortgages, the conversation tends to revolve around two primary considerations: goals and the financial environment as a whole. We’ve found that nearly every financial decision people face has both a numerical, hard data consideration and an emotional consideration. In this case, the emotional consideration is the desire to be DEBT FREE! It’s a great goal, and certainly one we can get behind. For many people, it’s the one financial rule their parents drilled into them. “Get out of debt as fast as you can. Pay off your mortgage before you retire.” Sound familiar? That’s good advice, but it doesn’t consider the big picture. The big picture has to include a discussion about the current financial environment. Today, we’re enjoying historically low interest rates, and have been enjoying them for a historically long period of time! The downside: safe places to save money, like banks, pay extremely low interest. The upside: rates to borrow are also very low. What does that mean for investors and borrowers? There’s a good chances that it makes better long term financial sense to borrow money than to pay down debt. As the saying goes, “Make money using someone else’s money.” Consumers who recently refinanced in order to take advantage of the low rates are a good example. Another common example is the people who choose to finance a new car rather than pay cash. These people know that their money may be able to work harder for them in IRAs, 401(k) plans, or other suitable investments.

We’d be remiss if we didn’t offer a few words of caution. First, historically low rates are not an excuse to load up on debt without full consideration of the risks. Two, borrowing money with the intention of making risky investments can backfire. Exercise caution. Three, credit card companies are not required to, and indeed have not chosen to, reduce the rates they charge cardholders to correlate with federal interest rates. Credit card rates are still extremely high. Four, low interest rate are not an opportunity to avoid creating an emergency fund. All savers and investors should plan for rough times by having at least six months of fixed expenses set aside. The lack of an emergency fund could result in relying on credit cards, and that’s a burden no one wants to bear.

 

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

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