If you are in debt, you are not alone. The majority of Americans have some debt hanging over their heads – from mortgages to student loans to credit cards. Debt can be a burden and put a damper on many of your financial goals and plans.
Investing can be a good way to make a little extra money so you can pay off your debt faster. But is the risk worthwhile? For most people, you can balance your debt and investments if you approach the situation intelligently.
Good debt vs. bad debt
First, you should know the difference between good and bad debt. Bad debt, also called consumer debt, is money borrowed at a high interest rate that does not promise a financial return. It is using debt to buy things like clothing, vacations and other items that will not provide tangible, financial value. Bad debt is collected using credit cards and payday loans with exorbitant interest rates.
Good debt, on the other hand, is borrowed at a low interest rate and promises a high value of return. If you buy a house, for example, you are gaining value as you pay the mortgage. If you take out student loans, you are contributing to a higher education that will help you make more money in the future.
Since you are in debt, you are probably a little short on flexible cash, which you often need for an investment. Many investors take out personal loans to make their down payments. Personal loans can be incredibly risky if you are not smart about them, but if you read reviews carefully and choose from a list of the best personal loans, you can get a great interest rate that will support your investment without crippling your debt load.
If you are looking to invest, consider whether or not you are dealing with good debt or bad debt. Will you be able to make a high return on investment with the money invested?
Weighing ROI and interest payments
The biggest question people have is whether they should pay down debt with extra cash or use it to make an investment. The answer is found in comparing numbers regarding your return on investment and your interest accrual. If, by choosing to invest rather than paying down debt, your return on investment is lower than your debt’s interest, attend to debt first.
On the other hand, investing might be wiser if you can see the return will be greater than what you will owe in debt interest. You will earn more money to put toward debt.
An example of this is putting down $10,000 to purchase a rental property. Based on the market, you believe you can make 30% in profit from this investment. You also owe $10,000 on a credit card with an interest rate of 15%.
It seems obvious to pay off your credit card with the high interest accrual, but that might not be best. If you can keep your units filled, you will make a nice profit while gaining equity into the property. The short and long-term profits from your investment are ultimately greater than what you will owe in interest.
Taking the risk
The numbers only show the numerical potential of an investment. You assume you can make 30% in profits, but there is no guarantee. You could lose 30%. This significantly complicates your choice.
Consider your risk tolerance, which is influenced by things like age, income, time horizon, tax situation, earning power and any other criteria that could influence your investments. Most importantly, consider your willingness to assume risk.
At this point, it mostly comes down to personal choice. You will weigh the costs and risks, and if the chances for success are high, you might go for it. If you are a risk-averse person, you will probably step out and take the guaranteed win of paying off your debt.
It is a lot to consider and wise to consult financial officers and seasoned investors who can help you decide whether or not to go for it. Oftentimes, the emotional considerations are just as important as the numbers, so take your time and consider all your options.
When you should pay down your debt instead of invest
There are some instances where you should pay down debt before considering an investment. If your debt-income ratio is bad, it is not smart to risk much. You will have a difficult time guaranteeing the income you need to keep up with your payments.
Additionally, if creditors are banging on your door, do not take your money elsewhere. It is almost impossible to get a good loan without a good credit score, and avoiding past-due payments will hurt you more than help you in the long run.
You can always invest in the future. Do not sacrifice your personal financial stability just because you could not wait to make an investment when you were a little more secure.
Conclusion: investing with debt is possible but personal
Overall, it is possible to invest despite your debt, especially now that lenders are more comfortable with offering loans. It is all about considering your personal situation, gaining insights from those who have gone before and consulting financial advisors.
Ultimately, there is no guarantee you will make money from your investments. Can you handle the risk if it falls through? On the flip side, can you afford to not take advantage of incredible potential profits? Be prepared for either outcome, and do not lose sight of your potential for a more financially stable lifestyle.
