Should you be paying off debts or starting to invest?

In today’s world, the majority of people are in some sort of debt whether that’s through credit cards, cars finance or mortgages.

More people have started to invest as it becomes more accessible to the average person, mainly due to cheaper fees.

Pay off debts

Over the years debt has been looked down on by people who think everything should be paid off when it can be but as you’re about to see that’s not always true.

Different types of debts have different interest rates, bad debt has much higher interest rates than good debt. Bad debt, such as credit cards and payday loans have massive interest charges of over 20%. Over time you end up paying more in interest than the actual loan you took out. Good debts including mortgages, some personal loans and car finance have lower interest rates usually between 2-7%. These types of loans are much more affordable and can sometimes be more beneficial than paying in cash.

Start Investing

More and more people are investing and it could be more beneficial in the long run than paying off debts but this isn’t always the case. You should look into each debt and each investment to weigh up its real return. A good fairly risky investment into shares could return you around 10% a year, bonds around 4% and saving accounts 3%. Returns are not guaranteed with investing and you could end up with less than you started with.

So what should you do?

If you believe your investment is going to return a higher percentage than your debt than you should consider investing as it will provide you with a real rate of return. Let’s say you have £100,000 and don’t know whether to pay off your mortgage or invest the money. If you have a mortgage of £100,000 at 3% interest you would repay £3,000 interest a year. Let’s assume you put that £100,000 in a stocks and shares ISA that returned 10% you would have made £10,000. You would be £7,000 better off if you made the investment rather than pay off the debt.

To conclude if you have good debt with low interest rate loan then you are probably best starting your investment journey than paying off the debt, as long as can tie the money up for at least 5 years (ideally over 10). Any debt you have with over 10% interest should be paid off as your priority as it is unlikely your investment will return more.