Two weeks ago I had an e mail from a listener asking if her and her husband should pay off their $30,000 line of credit, will still contributing $400 to their RRSP each month, or to stop contributing, and focus on the debt? Unfortunately, there’s no black or white answer, and the note didn’t have any information about their income, tax bracket, etc.
Paying off debts is way more of a psychological and emotional issue than it is about math. If it were about math, who on earth would be dumb enough to run up debt on a 19% credit card? Who would finance a vehicle that depreciates so quickly AND adds thousands of dollars of interest on top of something that’s worth less each day?
That’s why I generally advocate stopping your investments while you clean up your debts. It’ll make it go that much quicker, and you get the huge self-confidence that you’re making progress each month.
There’s also no better return than getting out of debt. With a 19% credit card, you’re paying after-tax money. The chart to walk you through what your rates really mean is in the It’s Your Money book. So, that 19% card is really costing you 27%. And there isn’t a reasonable investment on the planet that’ll make you 27%.
The issue is a little different when it comes to a line of credit that’s likely in the 4 to 5% range. It’s also different for someone who has a substantial income and can pay off their debts within a year or 18 months.
If this couple is in a high tax bracket, the RRSP savings will net them a great tax return that should then go on the PLOC immediately. So essentially, half the investing is still going onto debt.
If they stop the RRSPs, it’s only for a year or so. It’ll give them way more traction, save a bunch of interest, and get it done two years faster. But that depends on whether they are really committed to paying off the balance in the first place.
Lots of people kid themselves that a line of credit is no big deal, because the interest is so low (forgetting it’s after tax money, that rates have already gone up ¾ of a percent, and often that size line of credit is secured by their home, and they keep using the line of credit…)
Anyone who is making some pretty steep payments on their debt anyway, and is seriously committed to getting debt free should absolutely stop investing for one year, and get their debts paid off and closed. If it’s going to take two or three years, it’s your decision: Get debt free fist, or just reduce your RRSP contributions for a while.
Whatever you do, this week, you need to do a written budget of where your money is going, and I bet you can find $100 to $200 in your budget that’s leaking out right now, and can go to the PLOC without you even noticing much of a lifestyle change at all.
When we focus on saving and paying debts and this and that, we know none of these will get done with much intensity. When we have a single-minded focus to pay off one or two balances, you’d be amazed how quickly it happens. If we want to…