Increase Your Debt Payments for Guaranteed Returns

If you have debt and are making regular payments, increasing the amount of your payment will give you guaranteed, tax free interest savings, not to mention getting rid of your debt faster. With high interest debt these savings are almost always greater than returns you could make by investing your money. Even with lower interest debt such as mortgages and student loans, you may be surprised what the guaranteed rate of return amounts to when you add to your regular payments, especially compared to taxable investment returns. Let's look at an example:

With the above debt, interest rate, and monthly payment, you'll need to make payments for 161 months (13.5 years). Your total payments will amount to $145,215. So over 13.5 years you'll end up paying $45,215 in interest alone! And that's with a relatively low interest rate of 6%. Here's what happens if we add $100 to the monthly payment:

As you can see above, adding just $100 to your payment allows you to pay off your debt 2 years earlier and save $7,235. in interest payments. This amounts to a 6.86% return, tax free. In order to see the same return by investing your money you'd need to make a guaranteed return of more than 9% if your marginal tax rate is 25% (a low number for the sake of this example). It's unlikely you'll make 9% by investing your money, and it certainly won't be guaranteed. Let's look at the affect of adding $200 to your monthly payment:

By adding $200 to your monthly payment you'll pay off your debt more than 3 years sooner and save $12,445. This amounts to a 7.73% tax free return. Notice that adding a larger amount to your monthly payment results in more interest savings and a greater tax free rate of return. This is why paying off high interest debt is nearly always better than investing your money. It's a no-brainer. If you have high interest debt you should pay it off before investing money elsewhere. (The only thing you should potentially do before paying off high interest debt is get insurance and create an emergency fund. See our 10 Steps to Financial Success article for more information.)

The decision to payoff debt or invest gets a little tricker when you've got a very low interest loan or great investment opportunities. You can use our free Invest or Payoff Debt Calculator to see exactly how much interest you'll save by adding to your debt payment and our Compound Interest Calculator to see how much you can earn with other investments. Keep in mind though that most investment gains will be taxable, whereas the savings you'll get from paying down debt will not. Additionally, consider how much better paying off your debt will make you feel.