Pay Off Debt Fast or Build Assets?

Is it me, or are there a ton of people out there right now that get really hot and heavy for this whole pay off debt fast thing?  I mean, I’ve read so many posts about eating the free range crickets that live in your basement for cheap nourishment, or hooking your bike up to the power grid that my eyes are actually watering.  Yes, I would rather have all my currents debts paid off than be in my current financial position… because then I could turn around and put myself in much better debt all over again!  Now if you’re wondering what the heck I’m talking about I’m going to assume you haven’t read a few of the numerous posts (or books) on the difference between how wealth-builders and extreme-savers go about accumulating a nest egg.

 Cricket – It’s What’s For Dinner

Extreme savers believe that everyone should pay off debt fast because it feels good.  I’m fairly certain at this point that for many in the PF community it is actually an aphrodisiac.  Hey I guess that’s all fine and good, but for me, money is just a tool, and consequently, money that I owe someone is just a tool as well.  I believe that with a couple of caveats, it is much more productive for people to focus on building assets than it is to focus on paying off debt fast.  I don’t want to earn a million by eating Ramen noodles and stacking coupons for hours on end.

 If You’re Allergic To Debt, Take Some Claritin

Wealth-builders (like myself… only I haven’t really built much yet) see debt as an essential part of their overall strategy.  By taking out investment loans and paying interest that is tax-deductible, while realizing average market returns (over an extended period of time) you are building a nest egg with other people’s money.  If the stock market isn’t your game, take out a loan to expand your small business, or become a landlord, or use a loan to take a course and expand your credentials and earning power.

Debt doesn’t kill people, people who irresponsibly use debt kill people.  I’m not advocating that people take out consumer debt (or “bad” debt as most people call it).  Although it is noteworthy to point out that some pretty famous and successful people have maxed out their borrowing capacity to fund their dreams at one point or another, I probably wouldn’t recommend this for most people.  Credit card debt, lines of credit, and any other debt that has interest levels higher than you feel you could gain as a rate of return on your investment don’t make much sense to keep in your tool belt.  If you can find an investment that beats the interest rate on most credit cards you should seriously give your old pal TM a call!  People who take out “interest-only” mortgages, or cripplingly high student loans, or rack up credit card debt, give the rest of us debt-lovers a bad name.

 If You Can Make It Faster Than The Bank Will Take It, You’re Good To Go

You see not all debt is that bad.  Right now my mortgage is costing me a little over 3%.  If I can’t build assets that beat that rate of return then I shouldn’t call myself a wealth-builder.  My girlfriend’s student loan debt (around 25K) is sitting there right now as she finishes school.  I could lose sleep every night thinking about it, but instead I turn my brain on and realize, “Oh wait, they’re lending her money for free, and then when she graduates, it will still be free money for 9 months… and after that, the interest we pay will be tax deductible, which means it will probably have a similar real interest rate to my mortgage.”  You see why would I rush to pay the debt off?  Instead I want to jump start the asset side of my ledger, and I’ll worry about those pesky debts when I’m good and ready!  The ultimate conclusion of my mindset is to begin the Smith Manoeuvre.  The government is actually willing to pay me (through tax deductions) to borrow money and build assets with it.  How cool is that?

 Case Study In “Pay off debt fast”

My parents are huge fans of the traditional view of paying everything off as fast as possible.  They live comfortably now, and you could certainly do far worse from a personal finance perspective.  Now imagine how great they could have done had they used debt to their favour.   My dad built our house with his own two hands and never owed a cent on a mortgage because he had been saving for years as he worked hard jobs (cutting wood, building railroads, welding, etc).  That’s a pretty cool story (and one I’m obviously proud to tell from a human interest perspective), but it’s interesting to note that while my dad was saving all that money in an account that was taxed at a very high rate (taxes on interest income suck) the economy hummed along at a record clip.  Imagine how much money my dad could have made by simple taking out a mortgage at variable interest rates, and allowed all his saved money to compound in ETFs/Index Funds in his teens and early twenties?  He would have easily been a millionaire by 45.  Obviously I’m cheery picking this example, but the point remains that the “save at all costs, always pay off debt fast” mentality often ends up costing us a lot in the end.  Young people should stay away from high consumer interest rates, but after that commandment, focus on being an asset-builder and chill on that anti-debt fetish.

Anyone else out there love debt as a great tool in their tool belt, or is “Pay Off Debt Fast” always the way to go?

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12 years ago

I agree that low interest rate debt doesn’t need to be a priority. In fact, it took us 10 years to pay off our student loans. Now I take more of a balanced approach, paying an additional $600/per month on our mortgage while also maxing out our TFSAs. If I remember correctly, you bought your house for $100k. That’s 3.5x less than the national average. I think you’re in a good position to focus more on asset building than on reducing debt. However, I can see why people with 3-4 times the mortgage debt would want to be more aggressive… Read more »

12 years ago

You are so right. People can get so hung up on reducing their monthly debt payments [via paying off their debt] whilst forgetting that eventually they are going to have to retire. One can’t live off of debt payed off but instead everyone must have some source of income [ie wealth].

12 years ago

Make the most of it and go nuts early, if it all goes to pieces you will still be young enough to start again! I had a similar philosophy to you when I was younger, I certainly made debt my friend! I’m trying to consolidate now that I have kids so that we can be more comfortable.

This is always an interesting question to ask. For me, if the interest rate is low enough I think it is best to save first but if interest rates are high it doesn’t make sense. Depending on the situation one would do different things. Being debt free is a great feeling though.

12 years ago

I think we need to distinguish the difference between government student loan interest that is tax deductible and lending institution student loan interest that is not tax deductible. I don’t see that too often in these posts.

Reply to  Teacher Man

That is the funny thing about that maneuver. As much as it works you also always owe money. Hope it works out for you.

12 years ago

Between March 2005 and March 2010 I “aggressively” paid down my mortgage (5 year fixed, 4.65%, 20 yr amortization). During that same time period the TSX returned 3.82% yearly (and my RSP mutual funds fared much worse of course). I think I came out comfortably ahead by paying off debt. Granted I no longer aggressively pay it down – opting instead for stocks inside my TFSA. That’s been growing 11% yearly, including dividends. Much better than the 3% variable on my (now tiny) mortgage. So both approaches have merit.

12 years ago

I paid off all my debt in 10 years (house mortgage, car loans… everything).

That said, if I could have taken out zero percent financing on my cars, and a low interest rate on my mortgage I don’t think I would have paid off my loans in 10 years…

While I was paying off my debt, I also put about 15% of my paycheck into a 401k (and still had enough to put a bit into my kids’ 529).

So i agree with Miss T, if interest rates are high, pay it off more quickly, if not then invest :)

12 years ago

I am tending toward a more balanced approach. I have used debt to acquire and build assets but now am working to pay off that debt while those assets cover their costs. I don’t think it will hurt in the end but it can make for some tight months.

12 years ago

The SM has some advantages for those who have no intial capital to invest but it also has it’s risk especially if you intend to keep the debt indefinately..Situations where interests rates go high that coincide with market crashes could prove devistating to someone 100% all in who started this scheme on a tight budget already. Since a stable dividend paying company is pretty much paying me the same (less after taxes) as I am paying out in interest on my current mortgage I choose to eliminate that debt…I still manage to get money into the markets though but i… Read more »

12 years ago

Why not do both? We’ve been investing and saving for some time, and are now setting our sights on paying off the house.

We are aggressively paying down consumer debt. When that is gone we will be left with student loan debt. Then we might slow down the debt repayment so we can save for a down payment on a house.

12 years ago

I am also in the same page when someone says low interest rate debt need to be a priority. In my opinion it generally takes eight to ten years to pay off your student loan. This prompted me to be various conscious and meticulous towards loans and debt collection. me to take If I remember correctly, you bought your house for $100k. That’s 3.5x less than the national average. I think you’re in a good position to focus more on asset building than on reducing debt. However, I can see why people with 3-4 times the mortgage debt would want… Read more »

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