Hoping my little paradise will return more than my debt’s average interest rate.
I compile all my net worth data around the 10th of the month, which is when all my monthly payments are done
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Utilities on rental property
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Taxes
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Consumer loans (used to buy some land and invest)
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Monthly credit card balance paid in full
Then between the 10th and the end of the month, I usually have no moves on my account and can have a clear look at my net worth.
The liabilities column of my net worth is decreasing regularly with the monthly mortgage and loan payments, but it has been a while since I have made an extra payment towards my debt.
Paying my mortgage early, in spite of the amazing feeling that it could bring to be mortgage-free doesn’t make financial sense to me. My interest rate is at a super low 2.29%. I have a 3% savings account. No way I am repaying that early and making the bank some money. I repaid part of my 7% loan earlier this year and when it was time to buy a property lamented not having the cash at hand.
This time I wondered what was my debt average interest rate, to see if it makes sense to repay any debt early.
HOW TO CALCULATE THE AVERAGE INTEREST RATE ON YOUR DEBT
Calculating it is pretty easy. Line up all your debts and interest rates.
Debt A $1000 at 5%
Debt B $5000 at 3%
Debt C $25000 at 7%
Total owed $31000, but at what rate?
Multiply the amount owed by the interest and sum it.
(1000*.05)+(5000*.03)+(25000*.07)= 1950
Divide that by the total amount owed 1950/31000= 6.29%.
My debt has an average interest rate of 4.73%. Every month, over hundreds of dollars are paid in interest towards that debt.
While I don’t have the cash to cover my debt instantly, I should get the money from the flat I sold in Paris next month, and a good chunk could go towards my debt. It will not.
Here is how I view this debt: it is a cheap loan to allow me to invest my money in more rewarding assets. I mentioned earlier that I own 56 bulls as part of a cattle investment. This investment alone is covering my debt interest payment. And I invested a fraction of the debt in it.
Every month, as I repay the interest and some principal on my loans, I pay less interest and my net worth grows.
So instead of repaying my debt, all my extra money will go towards fixing my house in Guatemala, and developing the 90 acres of land behind the house. I would like to sell plots for people to build houses on, maybe a green development or something, the ideas are pretty vague at the moment, but I think I can return much more than the 4.73% that I would get by paying off my loans.
I would always recommend that you pay your debt early, specially consumer debt. In this case, because interest rates are low, and my normal payments are already covered, I think it makes sense to pay interest for a few more years.
Have you ever calculated your average interest rate on debt? Does it make you want to pay it faster or keep with normal payments?
Now that we have paid off all of our consumer debt, we are focusing on paying off our house. It’s only at 3.25% so it’s a little silly but we are also saving and investing money as well. It should be paid off in about 35 months and we crave the psychological freedom that this will bring. But to each their own. There is no wrong answer and I dont blame you for paying yours off!
I know I’d love the feeling too. Everything is on autopilot but still takes mental energy thinking about it.
This post is taking me back to my finance classes when we used to do all sorts of calculations related to interest. I don’t think it makes sense to repay early if you have a low enough rate. I foresee inflation being 6-10% (or higher) over the next 10+ years. I’m talking USD here, though,so it may be different in the currency you use.
6% per year? My debt is in GBP and EUR, Guatemala is kind of following USD, so I am trying to be smart with currencies too. That’s why I repaid part of my debt this summer because GBP was strong and I paid off some Euro debt with my pounds. Additional little return, but it is very hard to predict.
This is certainly a great exercise, but it’s one that I haven’t tried. Most of our debts have low interest rates; we haven’t paid extra on them in a long time but I am getting sick and tired of having them around. We’re currently going to allocate 80% of our disposable income for a house down payment and 20% towards extra on debt payments. I like your mindset though of earning more interest than you’re losing on your debts; if you can find a safe, mostly-guaranteed investment then I think it’s a good thing to do. If the investment has a lot of risk, then I’d avoid it.
My investments are a bit risky, but since I could still cover my usual debt payments if I lost the investments, then I am fine with it. Then having part of my 2.29% mortgage on a 3% savings account provides a safe return and can serve as emergency fund. Being young and with no family, I am fine with the risk on the rest.
Great work on the numbers Pauline. I would tend to agree that with the rates you’re looking at it doesn’t make a lot of sense to pay it off. But, then you have to weigh in the feeling of having the debt paid off. Like as has been said, there really is no right or wrong answer. That said, I’d probably take the route you are.
Having the debt around is annoying and sometimes I just want to pay it off and forget, even though my net worth would be slowed in the process. I wouldn’t tell my mum to do the same but at 32 it makes sense to take risks.
I half agree with you, but it’s working out for me to pay off the mortgage like this:
In the UK rates are ridiculously low, and I’m very lucky in one respect. I bought a tracker mortgage 12 years ago when the base rate was over 5%. Our tracker mortgage is 1% over base, so now base has dropped to 0.5% I am paying our mortgage off hand over fist. Yes, it’s very cheap borrowing at 1.5%, but I’m pretty sure such low rates are unsustainable and will inevitably go up at some point, so the lower my balance is, the less I’m going to pay at that point, and the more spare cash I’ll have.
You’re right Matt, my mortgage is a UK tracker too and I don’t expect it to stay so low for much longer. But it has been over three years at 0.5% base rate, and enjoying the cheap money to invest has been great.
In your case you have done very well out of the money, (I read your cattle post), but I remember things being very tight for my parents under the last conservative government when mortgage rates exceeded 15%, so I’m basically insuring myself against that possibility.
BTW, I found you on twitter after your post was retweeted by WorkSaveLive
I owe one to Jason then! I know I will have to repay more when the interest gets higher but hoping in the meanwhile to make more money investing. My coworkers who had really high mortgages were just happy to spend the difference in cash when rates went down in 2008 and I doubt they’ll adjust nicely when they go up again. Gosh 15% is crazy! I am considering fixing if it reaches 5%, just in case.
I have been that way with my student loans. They are at a pretty low rate, so I’ve invested elsewhere. I have also done stupid money things that would have allowed those to be paid off, but hindsight is 20/20. I am just about done with the mental aspect of having them, so I think they are going down next year.
What a relief it must be to make the last payment next year! I still have 3 years or so to be just on the mortgage, but think it makes sense while you are young to invest elsewhere.
Here’s the thing.
Some people have a high tolerance for debt and risk and some don’t. I think your decisions are very wise considering your interest rates and the long term plans that you have for your money.
Everyone looks at wealthy people and envies them but they don’t always understand that many of the wealthy people are that way because they took financial risks and many of them do have debt that they pay back strategically without worrying about it every night before they go to sleep.
Exactly. I sleep ok at night (or not, because of insects, but not debt hehe) and hope my strategy will pay. Most successful people have also failed numerous times before they succeeded so I am not too hard on myself if I don’t, because at least I will have tried.
Totally agree with your plan. We’re in the midst of paying down our highest rate loan, and then plan on paying off the $50K personal loan that we owe Mr. PoP’s parents. Technically the term on that one expires with a balloon payment due no later than 2015, so even though the rate isn’t crazy high, the family aspect and the short timeline make it a priority.
After that, though… there’s no way we’re going to pay off our mortgage any quicker than we have to when it’s sitting at 3.25%… We’re way better off investing money at that point, I think.
The family loan is a tricky one. Sometimes my mum lends me money like she did now while I wait for the two months period to get my last flat’s money. I used it to pay for the land here. I like that she is willing to do so and never borrow from her if I am not 1000000% sure to reimburse her when I say I will, but I prefer when I owe her nothing.
Financially you are being strategic and not reckless. Your debt is with projects that have high appreciation and passive income potential, and any investment will have an inherent degree of risk. I feel you are handling your finances wisely. God, that view is like your own slice of heaven. Good for you!
DC I remember doing those calculations in my managerial accounting class. I hated them.
It also depends on your risk tolerance and your situation. If you’ve got a secure gov type job, then you can take more risk with your money. But if you’re a firefighter or working in a dangerous profession, having that mortgage paid off might be worth it for the piece of mind. If the firefighter gets hurt with a mortgage, it’ll be a lot worse for them than if they didn’t have a mortgage.
You’re right, I think my position would change if I was older and had dependents.
I love going into debt to invest. With today’s low interest rates it simply makes sense for you to use your money from the flat on more lucrative assets. 90 acres is a pretty big place. You can even section off a part of it later to be a park or something. My mortgage rate is about 3.4% right now, but it’s coming up for renewal next year and maybe I can get it lower.
You post today is in the same vein, and at 3.4% I wouldn’t rush to pay back either. 90 acres is huge! I plan on developing half to get my investment back and keep the rest as is for the moment.
What country do you own property in at that low of a rate? I’m always curious to see how real estate markets work in other countries. My arm is at 3.125% for 7 more years so I have some time before deciding what to do next with my condo..
I have a UK mortgage with 25% downpayment, it is a tracker index at 1.79% above base rate (currently 0.5%)
I’m always interested in seeing the difference in interest rates between countries – here in Australia the standard variable rate is at a historic low around 6% (however you can normally negotiate a 0.8%-0.9% discount). This makes it quite an attractive option to repay mortgage debt early – the Vanguard Australian market index has averaged a 5.5% return over the last 8 years and the international index has done about half of that (I use 8 years because that is what Vanguard have available on their site, 10 years would probably make a more sensible comparison).
In the event of such low interest rates as the UK or even the US I can definitely see potential in focusing on building investments rather than reducing debt.
at 6% I think I would focus on repaying the mortgage as well, it is pretty hard to get that kind of returns consistently on the market.
Hi Pauline !
Thank you for this article. You have given the formula. But the math is a bit confusing.
Debt A $1000 at 5%
Debt B $5000 at 3%
Debt C $25000 at 7%
(1000 x 5%) + (5000 x 3%) + (25000 x 7%) = 1950
Where as you have written $2,030.
Then, if we divide 2030 by total debt of 31000, we get 6.54% which is right.
But then you have written:
My debt has an average interest rate of 4.73%
Where did you get this 4.73% ?
Is my maths wrong somewhere ?
Thank you for your kind help.
Regards
Hi Shunmas, thank you for the correction, it is indeed 1950, I don’t know where the 2030 came from.
That gives you a 6.29% on the example. Then I go back to talking about my personal case where I get a 4.73% on my debt (my mortgage, my loans, etc…) which I am not detailing in the post.
Sorry if it was confusing!
No problem Pauline, thanks for your prompt reply. Nice blog though 🙂