People can understand the urgency in paying off debt with a 15 percent interest rate. But what's the rush in paying off debt with a 3 percent interest rate?
Sarah Beth Glicksteen / Staff / File
Quite often, when I write answers to reader mailbag questions, I encourage people to keep pushing hard against their debts no matter the interest rate. Almost everyone agrees that it makes sense to rapidly pay off the 15% debts, but I’ll often get a lot of disagreement about the 3% debts. People will often ask why they should hurry to pay off a 3% debt. After all, they can get a better return in other investments.
The reason is simple. It’s all about the cash flow.
Let’s start off with the basics and explain what cash flow is. Cash flow refers to the amount of income you take in minus the required bills you have to pay. Ideally, you have money left over at the end of this process, and the more cash you have left over, the better. That cash can be saved for the future, invested, or applied to extra debt payments.
Let’s say, for example, that you’re bringing home $3,500 a month. You have a $1,000 mortgage at 6.75%, a $500 student loan payment at 3%, and another $1,000 in required bills (electricity, food, fuel, etc.). At this point, you must have $2,500 in monthly income to pay for your minimum required bills. At the end of the month, with a $3,500 income, you’re left with $1,000 to do with what you please.
Now, let’s look at your situation if the mortgage is paid off. You still has a $500 student loan payment and another $1,000 in required bills. You must have $1,500 in monthly income to pay for your minimum required bills. At the end of the month, with a $3,500 income, you’re left with $2,000 to do with what you please.
Because your mortgage is paid off, your monthly cash flow is far better than before. This helps you in countless ways.