Should you pay off debt or invest surplus cash?

• Income & Budgeting
• Investment advice
• Investing in shares
• Property investments

No debt is good debt - a popular principle our parents were taught, our politicians regularly preach and one many of us aim to apply to our lives to some degree. The reality is that we live in an ever-growing, ever-changing world where debt can accumulate as we expand our families, buy into the property market, take time to travel or start up our own businesses. So should we hold fast to the teachings of the generation before us or think about paying off our debt only after we’ve put our extra surplus cash into investments?

Paying off debt:

Peace of mind is hard to beat in any financial circumstance, whether it be putting money aside for a secure retirement or regularly reviewing your insurances. The same goes for debt.

Debt generally falls into one of two categories:

Deductible Debt (sometimes known as good debt) is debt that is eligible for a tax deduction on interest payments e.g. an investment loan is tax-deductible because it will add to your assessable income.

Non-Deductible Debt (sometimes known as bad debt) is a debt that isn’t eligible for a tax deduction on interest payments e.g. an owner-occupied property mortgage is a non-deductible debt because it won’t add to your assessable income.

Considerations:

• Pay off bad debt first; your mortgage, credit card and any outstanding repayments. The sooner these are cleared up, the greater investment flexibility you’ll have later on
• When considering interest rates, look to pay your most expensive debt first, or the one set at the highest rate (e.g. your credit card), before putting all your surplus money into your mortgage
• If you decide to invest rather than pay off debt, you need to ask yourself: what is greater, the potential return on the investment or the interest you are saving? In some cases it may be more advantageous to postpone repaying a loan if the potential after-tax return of the investment is higher than the savings made from repaying the loan. An good example of this is using a debt recycling strategy to pay down home loan debt and re-draw it as an investment loan.

In the know: It is important to consider your own personal situation, asset-to-debt ratio and level of risk as an investor when looking at both sides of the paying off debt vs investing argument.