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Invest or pay off your debt?

So you’ve got some spare money.

It could be a lump sum or some regular extra cash in your monthly budget. Either way, you want to do something financially meaningful with it. Is it better to dip your toes in the market or repay your debts early? Here’s why we think you should always, always pay off your debts before investing. Well, most of the time, that is.

Why it's good to dump your expensive debts

Visualise your finances as a watering can. When you invest, you’re essentially filling up your watering can to grow your wealth. But if you have expensive debts, it’s like having a hole in the bottom of the can so the water leaks out faster than you can fill it up. By paying off your debt, you eliminate the drain on your finances that is interest expense.

That’s why as a general rule of thumb, it’s usually better to pay off your debts before you start investing. One works for you, the other works against you. So it makes perfect sense to focus on getting rid of the one that could drag you down – your high-interest debts.

What about low cost debts?

Low or 0% interest deals can be a fantastic tool for managing your money. When you’re financially disciplined enough to pay off the amount you owe during the low- or interest-free period, they can free up your cash flow and give you valuable breathing space.

So if the returns you’re expecting 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? Well, maybe in theory. But here’s the thing.

Even if the interest rate for your debt is below 3%, there’s no guarantee that you will be able to beat that in the markets. Remember, investments returns are only expected – not guaranteed. And what if the stock market took a tumble? Then you could have losses as well as debts.

Another factor to consider is that paying a loan off ahead of schedule is not always cost-effective as there may be early repayment penalties.

One thing that’s certain is your debt, whether interest-bearing or not, is a commitment that you need to be able to fulfil. It’s on your credit rating as a liability. The last thing we want is for you to invest if it puts you at risk of not being able to pay off your debts.

This is why when we give investment advice, we take the time to understand your whole financial situation before making a recommendation. As part of that process, we’ll ask about your borrowing commitments and deduct any short-term debts from the amount you’d like to invest. Just so you know, fees and minimum investment amounts apply when you take our investment advice.

And long-term mortgage debt?

A mortgage is an exception to our ‘pay-off-your-debts-first’ golden rule.

Why? Because unlike short-term debts, mortgages are long-term commitments that have been priced to be paid off over the full term.

Also, by waiting until the mortgage has been repaid before you start investing, you‘ll be limiting your time in the market. And one of the strengths of investing is putting compound interest to work for you by giving your money time to grow.

It’s true that making overpayments on your mortgage could save you money on interest in the long run. To help you work out if it makes sense to pay off yours early, try the Money Helper website. However, not all mortgages are flexible so before you start making extra payments, make sure you won’t get penalised.

If your mortgage won’t let you make overpayments or limits them to 10% a year, it could make sense to put any surplus cash into an investment. That way you’d be effectively building up another asset for your retirement pot – although you need to bear in mind that investing comes with risk and you may get back less than you put in.

One final thought

It’s one thing to feel the pinch from time to time. It’s quite another to you feel that your debts are taking over. If you’re getting weighed down by money worries, don’t suffer in silence.

Our trained specialists can help to take some of the weight from your shoulders. So don’t put it off. The sooner you call us, the better. We’ll work with you to develop a plan for getting your finances back on track.

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