Acceptable vs. Problematic Debt
In general, you will want to pay off your debts before you start investing. But not so fast! You have to first decide if some of your debt is acceptable to have while you start investing or if you need to pay off your debt before you start investing.
When it comes to investing, not all debt is equal
You might have some debt right now such as student loan debt or a home loan, and you are only paying an interest rate of 3% or 4% on that debt. Do you need to pay it all off before you start investing? Generally speaking, no. You do not need to pay off this debt in order to start investing. This kind of debt is largely considered acceptable debt.
Acceptable debt should not stop you from investing
Generally speaking, low-interest-rate debt is the acceptable kind of debt. If you have a dollar that you can use to either invest or pay down the balance of acceptable debt beyond your current monthly payment, then you should generally use that dollar for investing purposes, provided that you still have enough money left over to meet all of your current obligations to repay your debt.
If I have acceptable debt does that mean I should just keep paying it?
Just because your debt is considered acceptable does not mean that you should simply keep paying that loan off until it is all paid. There may be opportunities to reduce the total amount that you will need to pay on that loan.
In the case of student loan debt, there may be opportunities for obtaining loan forgiveness on your debt. The Department of Education provides lots of information on how you might qualify for loan forgiveness here.
Here are some other steps you might consider taking if you have acceptable debt but wish to reduce your total payments on the loan:
• Refinance: You might get a new lender to pay off your current debt and enter into a new agreement with you under more favorable terms. In the case of a home loan, you might talk to a local mortgage broker to find out if there are any good opportunities to refinance your home loan.
• Consolidation: You might consider consolidating all of your debts into a single loan with one monthly payment. One way to do this is by taking out a second mortgage or a home equity line of credit. Or, you might take out a personal debt consolidation loan from a bank or finance company. This is similar to refinancing but involves more than one loan.
• Bankruptcy: In extreme cases, you might consider bankruptcy. Bankruptcy helps people who can no longer pay their debts get a fresh start by liquidating assets to pay their debts or by creating a repayment plan. It can be costly to go through a bankruptcy, however, and it will likely hurt your credit score and make it difficult to obtain new loans for a period of time.
• Statute of limitations: If you have not paid a loan for a certain number of years, a statute of limitations may apply to that debt which may mean that you are not required to make future payments on that debt under certain circumstances only. These statute of limitations rules vary by state so we recommend that you talk to a debtor's rights attorney in your state before attempting to make use of your state's statute of limitations on debt.
What is meant by "problematic debt?"
If you have high-interest debt (for example: credit card debt with an annual interest rate of, say, 17%), then you have debt that is problematic from the perspective of a would-be investor. Generally speaking, you are better off paying off your problematic debt as soon as you can.
For example, if you have a loan charging you 17% interest and the return on your investment is only 15%, then you are actually losing money by investing that money rather than paying off your debt. You would be better off paying your principal down to $0 and only then start to invest your money.
Alternatively, you may try to find some kind of debt relief (see below) before investing your money. This is because it is very hard to invest in a way that will reliably give you a return on your money that is greater than the rate at which interest accrues on your problematic debt.
What can I do if I have problematic debt?
For most people, simply paying off the principal of the loan is a good solution to problematic debt.
There are several options to consider with problematic debt:
• Negotiate a lower interest rate: Most people do not realize that they can call a lender, such as a credit card company, and attempt to negotiate a lower interest rate right over the phone. Doing so should not negatively affect your credit score.
• Negotiate a pay-off of your current loan: You might be able to negotiate a pay-off of your debt for an amount that is lower than your current balance of principal and interest. Keep in mind that it might affect your credit score negatively to do so.
• Refinance: You might get a new lender to pay off your current debt and enter into a new agreement with you under more favorable terms. In the case of a home loan, you might talk to a local mortgage broker to find out if there are any good opportunities to refinance your home loan.
• Consolidation: You might consider consolidating all of your debts into a single loan with one monthly payment. One way to do this is by taking out a second mortgage or a home equity line of credit. Or, you might take out a personal debt consolidation loan from a bank or finance company. This is similar to refinancing but involves more than one loan.
• Bankruptcy: In extreme cases, you might consider bankruptcy. Bankruptcy helps people who can no longer pay their debts get a fresh start by liquidating assets to pay their debts or by creating a repayment plan. It can be costly to go through a bankruptcy, however, and it will likely hurt your credit score and make it difficult to obtain new loans for a period of time.
• Statute of limitations: If you have not paid a loan for a certain number of years, a statute of limitations may apply to that debt which may mean that you are not required to make future payments on that debt under certain circumstances only. These statute of limitations rules vary by state so we recommend that you talk to a debtor's rights attorney in your state before attempting to make use of your state's statute of limitations on debt.
• Loan forgiveness: In the case of student loan debt, there may be opportunities for obtaining loan forgiveness on your debt. The Department of Education provides lots of information on how you might qualify for loan forgiveness here.
Conclusion
If you have low-interest-rate debt only, you can start investing now. But to the extent that you have high-interest-rate debt, you should resolve your high-interest-rate debt in some fashion before you start to invest.