The decision to pay off debt or invest extra money depends on several factors, particularly the interest rate on your debt compared to potential investment returns. Here’s a framework to help make this decision:
When to prioritize debt repayment:
- High-interest debt (above 6-8%) – Credit cards, personal loans, and private student loans typically have interest rates that exceed reliable investment returns, making them priority targets for payoff
- Debt causing significant stress – The psychological benefit of debt freedom can sometimes outweigh pure mathematical optimization
- Debt affecting near-term financial goals – If debt is preventing you from qualifying for a mortgage or other important financing
- Variable rate debt in rising interest environments – When interest rates are trending upward, variable-rate debt becomes increasingly expensive
When to prioritize investing:
- Employer 401(k) matching available – Always invest enough to capture employer matching contributions, as this is an immediate 50-100% return
- Low-interest debt (below 4-5%) – Fixed-rate mortgages, federal student loans, and some auto loans often have rates below potential investment returns
- No emergency fund established – Building liquid savings for emergencies takes precedence over both aggressive debt payoff and investing
- Long time horizon until retirement – Younger investors benefit more from early investing due to compound growth
Balanced approach options:
- 50/50 split – Allocate half of extra money to debt payoff and half to investments
- Sliding scale – Adjust the ratio based on interest rates (more toward debt for higher rates)
- Debt snowball with minimum investing – Focus on debt while maintaining small, consistent investments
Whatever approach you choose, don’t neglect emergency savings. Having 3-6 months of expenses saved provides the foundation that makes both debt repayment and investing sustainable over time.