Whether to pay off debt or invest is a common question. My answer is always: It depends.
Let’s look at Pat’s case. He is 30 years old and considering paying cash for a $200,000 condo. Should he pay off the home or make a down payment and invest the remaining money?
Matt: Do you have $200,000 available to buy the condo?
Pat: I have $180,000 in the bank largely from an inheritance and could come up with $20,000.
Matt: What are your financial goals?
Pat: Turn the condo into a rental in three to five years and retire in 20.
Matt: Do you have an emergency fund in addition to the $200,000?
Pat: No. I have $20,000 in a retirement account, $5,000 in savings and now $175,000 from the inheritance.
Matt: Do you have any debt?
Pat: Just $8,000 in student loans.
Matt: What is the current monthly rental value of the condo?
Pat: $1,250.
Matt: How much are the condo fees?
Pat: $200 per month.
Matt: Do you follow a budget?
Pat: Yes. I just started one when I began looking to buy a home.
Matt: How much are your currently monthly living expenses?
Pat: $2,700.
Matt: What’s your annual income?
Pat: $44,000.
I recommend using the following steps to achieve financial success. (You’ll see where I got the questions I asked Pat.)
1. Start with a small emergency fund of $1,000 – $500 if you make less than $25,000 a year.
2. Use a budget that reflects your priorities in four categories: Basic necessities, obligations, less-than-monthly expenses and small luxuries.
3. Pay off all non-mortgage debt as soon as possible.
4. Grow your emergency fund to equal three to six months of living expenses.
5. Pay off your home in 15 years or less.
6. Invest at least 15 percent of your income for financial independence.
Using these guidelines, here is what I recommended for Pat.
Pay off the $8,000 student loan debt. This will free up several hundred dollars a month.Place $16,200 in savings or a money market account for an emergency fund. Having an emergency fund is all about sleeping well at night. Don’t try to maximize your return by investing in the stock market.Use $100,000 as a down payment on a 15-year mortgage. The result will be a mortgage payment that will cash flow positively should it become a rental.Jump-start retirement by investing $50,000. Starting early means he’ll reap the rewards later!Invest $500 a month for financial independence. Consistent long-term investing is best.Now put your goals in focus and use these six steps to guide your choices to achieve your dreams.
Durango resident and personal finance coach Matt Kelly owns Momentum: Personal Finance. http://www.personalfinancecoaching.com.
