Should You Pay Off Debt or Invest?

What is the best thing to do with your spare cash, pay off debt or invest? The answer, as you might expect, is that it depends.

There are definitely some general rules to follow, though, and for the most part, we encourage our clients to pay off debt before they start investing. Here are the most common scenarios we see ranked by priority, and what we’d recommend for each one.

Always pay off high interest, revolving debt first

If you have high-interest debt, like credit card debt, the best use of your money is paying it off. We always recommend tackling your credit card debt or any other high interest revolving loans before investing or paying off other types of debt.

Here’s why: let’s say you have $10,000 on your credit card (which is a revolving loan) and $3,000 in cash. If you use that cash to pay down your credit card and something happens next month and you need access to $3000, you can always put it on your card. If you had used that $3,000 to pay down a non-revolving loan (like your student loan) you wouldn’t be able to access that money again, and you’d have to put an unexpected expense on your high-interest credit card.

Don’t forget, interest you pay on your credit card far outweighs any return you’d see in the market!

Pay off your personal lines of credit before investing

Even though lines of credit have lower interest rates than credit cards, we always recommend paying yours off before investing. Some people like to play the numbers game here and argue that they could get a higher rate of return investing their money in the stock market, but we’re not fans of leveraging.

The stock market, despite what anyone has tried to convince you of otherwise, is totally unpredictable in the short-term. You never know when things might take a dip, so we always recommend paying off your line of credit first before investing for stability’s sake.

Also, if you need to cover an unexpected expense, it’s much easier to take money from your line of credit than your TFSA or RRSP.

For non-revolving credit like a student loan or a mortgage, it depends

We always recommend paying off revolving credit before doing anything else but, if you have non-revolving credit like a student loan or a mortgage (which tends to be at a much lower rate), you might prefer to invest extra cash over making additional payments on your student loan or mortgage.

It’s really important to have cash or near-cash on hand in case something happens and you need to cover an unexpected cost, so you always want to make sure you have a healthy emergency fund before you start thinking of making extra payments. If you have $3,000 and you don’t have any savings or investments, always choose to save or invest that money instead of making an extra loan payment.

If you already have a hefty emergency fund and you’re on track with your retirement investments, you may feel more comfortable using an extra influx of cash to pay down your student loan or mortgage. Totally depends on your risk tolerance and what helps you sleep better at night!

Our general rule of thumb

Finally, here’s a rule of thumb we often share with clients that helps them make their own best decision—would you borrow the money required to make the investment you’re thinking of? For example, would you borrow $500 from your credit card to invest in the stock market? Probably not, seeing as you’d pay close to 20% interest on that money, which tells you that you should use any extra cash to pay off your credit card.

Ultimately, we see clients happier and feeling more at ease when they focus on paying off their debt first (aside for mortgage debt—we totally encourage you to invest for your retirement alongside paying down your mortgage).