How To Tackle Debt And Investing | NerdWallet

Hi, I'm Sean, a finance nerd. And today we're going to talk about when to prioritize investing or debt payoff. And I'm joined in this conversation by my co-host, Elizabeth Ayola and NerdWallet Debt Rider, Tiffany Curtis. Let's get to it. This episode's question comes from Alex who sent us a text message. Here it is. I have a question regarding loan payoff strategies. I am currently on a snowball payoff strategy starting with my higher interest car loan at 6.9%. But I also have loans at 3.9% and a mortgage at 2.8%. At what rate does it stop making sense to prepay loans to become debt-free and prioritize investing more? Thank you, Alex. Well, to help us answer Alex's question on this episode of the podcast, we're joined by Tiffany Curtis, a debt writer at NerdWallet. Welcome back to Smart Money, Tiffany. Thanks, Sean and Elizabeth. I'm happy to be here and I hope I can help. Oh, I know you will. All right, so let's dig into the topic, guys. Our listener mentioned that they're using the debt snowball method to pay off their debt. Can you start by describing what this is for us, Tiffany? Yes, so it's an approach to debt that focuses on paying off your smallest debt first. And once that's paid off, you take the amount that you were putting on that one and you move it over to the next largest balance. And then you keep that pattern going. So with every debt that you pay off, the amount of money that you're putting towards your debt grows like a snowball rolling down a hill and slowly getting bigger, hence the snowball method. So in Alex's case, for example, the debt snowball method would look like prioritizing, putting more money towards whichever debt has the smallest balance first, which could be the loan with a 6.9% interest rate or the loan with a 3.9% interest rate while continuing to make the minimum monthly payment on the other debts. Remember, with debt snowball, you're focused on the account balance and not the interest rate, and then rolling that money to the next largest debt. Right, and the debt snowball method is often compared with the debt avalanche method because we love our snow analogies in the debt payoff space, I suppose. So can you talk about how this one works? Sure, we do love a good snow analogy. I think that having a visual of your debt payoff, be it snowballs or something else, it can help make it a little easier to understand the method. The debt avalanche is the opposite of the debt snowball method. Instead of focusing on paying off the smallest debt first, you tackle the debt with the highest interest rate first while making the minimum monthly payment on your other debt, and then you roll that money into the next highest interest debt to the debt, and then you keep it going. So with our listener, Alex's debts, they would focus on paying off that 6.9% car loan, then the loan at 3.9%, and then the mortgage at 2.8%. And thinking about their question, I'm kind of wondering if they're actually doing the avalanche method instead of the snowball because they can be kind of easy to mix up. Wow, that was a tongue twister, guys. Listeners, I hope you're following along. All right, Tiffany, so how can someone determine which payoff method might be better for them? Well, first, I think it helps to figure out whether you'll be more motivated by small and quick wins, which you get with the debt snowball method, or if you're more of a patient and analytical person who can stick out the debt avalanche method, which may take longer. So paying off your smallest debt first may give you the energy to stick out paying off your debt, while the debt avalanche method could lead to you growing weary, especially if your largest debt is also the one with the highest interest rate. At the end of the day, I think the best payoff method for you depends on your goals and how you approach money. So you have to be honest with yourself. That's a really good point, Tiffany, because people love to argue about the debt snowball and the debt avalanche method and say one is always the best way to go. A lot of people who are more mathematically minded, perhaps, may say avalanche is always the best because it can save you money depending on how your debts are structured. I tend to prefer the snowball personally because I think that psychologically, people paying off debt and getting the benefit of closing out an account can keep people going over the long run because debt payoff can be quite a slog. But like you said, Tiffany, it really all depends on your own personal circumstances, how you are mentally and your financial goals. So, Sean and Elizabeth, our listener is wondering about when it makes sense to focus on investing instead of paying off debt. What do you guys think about that? While we are not financial or investment advisors and don't give personalized financial advice, I do like to multitask if possible, and that can mean both investing and paying off debt at the same time. And this is because life is frankly too short to only do one thing with your money at a time, in my opinion, and you can very likely make significant progress on multiple goals at the same time. And our listener asked about at what rate it makes sense to focus on investing instead of paying off debt. I would say our listener may have pretty affordable debt. Their car loan is a little pricey at around 7%, but their mortgage is at 2.8%. I'm guessing they got that in the early days of the pandemic. And their other loan, which I didn't specify the nature of is at 3.8%. All in all, that is pretty reasonable, especially compared with credit card debt, which can have an APR well over 20% right now. For sure. I think that is reasonable, Sean. And it can, if you're like me and debt is like an itch in your foot, just want to get rid of it. But sometimes you really have to do the math and think about what makes more sense. So on that note, you can compare that with investing in the stock market. Some people have historically been able to get around, let's say 10% returns over time, which is pretty decent. So you can get a greater return by investing than by paying off your debt. If you factor in inflation, which erodes the value of your money, and investing can seem like an even better deal. So a question that our listener can ask themselves is, where can I get the better return on my money? Paying off a credit card with an interest rate north of 20% is likely going to give you a better return than investing in the stock market. But returns aren't the only thing to consider. You do have to think about your own individual circumstances, financial goals, and if having debt is a horrible itch in your foot that you just want to get rid of. That's something to think about too. But I will say this is a really common question among listeners, and it's something that many nerds deal with too. Thanks for watching. I'm Sean Piles, host of NerdWallet's Smart Money Podcast. If you learned something new today, hit like and subscribe, and share with your friends. Also, listen to NerdWallet's Smart Money Podcast wherever you get your podcasts.