Many Americans believe debt is always bad and should be paid off as soon as possible.
And normally, it’s good to minimize your debts. However, there are a couple debts that can give you a financial advantage… even profits.
Ask most people about their student loans and their first thought is, “I can’t wait to get this paid off”.
A worthy goal but if you look at the interest rates you’ll see something most people miss.
Student loans traditionally carry a low, simple interest rate and this can make them a debt worth carrying.
The time value of money
Let’s say you have $30,000 in student loans with a 4% interest rate and 30 years to pay them off. Some people will see the total cost of $51,480 and want to pay the loan off right away. Others will want to pay it off early because they just want the debt off their mind and to be done with the payments.
This is where things get interesting…
If the borrower can look past those two reasons, they could make themselves quite a bit of money with compound interest.
Instead of paying off the student loans right away, they could invest their $30,000 in something simple like an index fund. And if the fund is making 7%, the original investment would grow to about $228,000 over the 30 years!
This difference, (almost $200,000 dollars worth in this example) is due to compound interest which is interest earned on top of past interest and original principal. Plus, the $228,000 does not include the effect of adding additional funds into your investment account over the 30 year period. That amount is simply calculated by investing the $30,000 and not ever investing another penny.
Another debt worth keeping is a home mortgage. Just like student loans, these mortgages are simple interest. If a consumer buys a home for $200,000 today and gets a mortgage at 4.5% over 30 years – it would cost them $364,813 in total.
If you have the ability to pay for the house with cash but instead decide to get the mortgage and invest the cash, you could profit. Investing the $200,000 one time into a fund that averages a 7% return rate over 30 years would end up paying out approximately $1,522,000!
That is the power of time value of money and compound interest.
Even if you cannot payoff your student loans or mortgage in one payment, you can still benefit from compound interest.
If you are thinking of paying more than your normal monthly mortgage payment, you might want to consider investing it instead. One of the biggest benefits to investing the extra money is if you need some emergency cash down the road. It is a lot easier to pull the funds out of your investment than from the mortgage.
Another benefit is if you get tired of paying the monthly amount on your debt 5-20 years down the road, you can use your invested funds to payoff the debt.
So there you have it, two examples of when debt is okay and how to even profit from keeping them.