Making extra money gives options. Do you pay off debt faster or put cash into investments? It can be a tough call.
High-interest debt that causes balances to balloon is draining. However, investing early can build wealth through compound growth. Prioritising matters. If you’re unemployed you may have a lot of debt piled up! You can take on benefit loans from direct lenders easily! These provide accessible financing when out of work.
Focus any windfalls or freed-up cash on high-rate card and loan balances first. This saves major money on expensive compound interest. Run the numbers on your highest rate debts. See how quickly extra payments make an impact and what total interest they save over time. It likely beats stock market returns.
| Loan Amount | Typical Interest Rate (APR) |
| £1,000 – £5,000 | 7% – 36% |
| £5,000 – £10,000 | 3% – 20% |
| £10,000 – £25,000 | 3% – 10% |
| £25,000+ | 2% – 5% |
Factor in Your Risk Tolerance
Deciding between extra debt payments and investing involves risk assessment. Payoff guarantees saving interest costs. Returns on investments fluctuate, sometimes losing money.
Debt Payoff Guarantees Set Return
Chipping away at credit cards, loans, and mortgages provides a sure thing – less interest owed. For example, paying a 20% APR credit card balance always saves 20%. This beats a risk-free high-yield savings account.
You control debt payoff outcomes because it relies on your payments, not market performance. The “return” is concrete each month – lower interest fees as balances drop. Guaranteed savings appeal to risk averse personalities.
Investing Returns Vary and Can Lose Money
Unlike debt payoff, investment returns vary year to year based on market factors you cannot control. Historically the equity markets trend upwards long term. But some years see negative returns.
Stomaching ups and downs takes an appetite for risk and uncertainty. Invested money can also be lost partially or entirely in unlikely worst case scenarios. Very conservative investors dislike this uncertainty.
More Risk Okay If Time Frame Is Long
If investing for retirement decades away, short term wiggles hardly matter. Time smoothes volatility so average returns have decades to play out.
Young investors should target growth aggressively through stocks since they have time. Paying off a mortgage early may not beat long term compound market returns.
Those nearing retirement have less wiggle room. Preservation of capital takes priority over growth. Paying off low rate fixed mortgages provides safety. The risk tolerance shift comes with age and timeline.
Joint Personal Loans
For large expenses, consider a personal loan with fixed rates and terms. These provide set interest costs without variable market risk. They also allow co-borrowing to get better loan rates and terms.
Joint personal loans with a partner combine incomes and credit histories. This unlocks bigger loans with lower rates versus borrowing alone. It also splits risk and responsibilities between co-borrowers.
| Criteria | Requirements |
| Minimum Credit Score | Typically 600 or higher for both applicants. |
| Minimum Annual Income | Combined income of £25,000 or more. |
| Employment Status | Stable employment for both applicants, with proof of income. |
| Relationship | Co-applicants must be spouses, partners, or family members. |
Consider Your Time Horizon
Whether paying down debt or investing makes more sense depends partly on your timeline. Freeing up cash flow takes months. Growing investments takes years or decades.
Getting out of debt payments faster has advantages. Eliminating credit card, auto, and student loan payments gives immediate cash flow relief.
Say you pay an extra £500 a month and wipe out a high-rate credit card in 6 months. That newly freed-up £500 can then go toward the next debt. Plus no more accruing interest on the paid-off card.
The freed-up monthly cash flows snowball onto the next debt. In a relatively short period, all extra income isn’t tied to debt service. Your money and options expand quickly when debts fall.
Investing Takes Years or Decades to Grow
Investing works differently over long timelines. Say you put £500 monthly into index funds. Don’t expect much account balance change in 6 months or a year. Stocks are highly variable short term.
But over 10, 20, and 30+ year periods, average annual returns of around 7% start compounding dramatically. What matters most is continuing to contribute consistently during up and down markets.
It takes patience and a long view to realise investing goals. But priority shifts once high-cost debts are paid off in the near term freeing up cash flow. Investing captures time and compounding long term in a way debt payoff doesn’t.
Estimate Potential Returns
Choosing the best use for extra money means projecting possible returns, both on debt and investments. Historical data gives us guidelines.
Compare average stock market returns to interest rates owed on debts. The bigger the gap, the more investing may favour accelerated repayment.
Market Historically Returns 6-7%
Looking at stock returns over very long periods, investors have seen average annual returns of around 6-7% after inflation. Periods of extreme volatility did hit, but 30-year rolling averages tend to normalise.
That range of 6-7% provides a reasonable expectation for long-term equity investing. Some years and cycles beat it. Some come under. But overall it stands over decades.
Of course, paying down debt provides steady, guaranteed returns equal to interest rates owed. So if rates on your debt exceed 6-7%, attacking those balances likely makes more sense short term than investing the same amounts.
Compare To Interest Rates On Debt
Now line up your rates on credit card balances, auto loans, student loans and mortgages next to estimated 6-7% investment returns. Where are the gaps biggest?
For example, credit cards often charge 15-25%. Paying these down faster guarantees saving that interest. Investing would be unlikely to beat a 25% debt rate over the same 6-12 month periods it may take to pay off balances.
Conclusion
Once you pay off any debt charging over 10% interest, investing becomes the priority. Under 10% is a more reasonable debt to carry longer term. Now put your money into retirement accounts like IRAs and 401(k)s especially. These grow tax deferred over decades. Ideal for compound returns. Next fund brokerage investment accounts. Index funds that track whole stock markets are recommended. Steady, diversified growth suits most people best in the long run. Give your money time to work – 20+ years ideally. Don’t panic sell in down markets. Ride out volatility and trust compound averages. Debt freedom gives you investing flexibility at the right time.
Jessica William operates as a Senior Consultant and Chief Content Editor for 10 years at 1Onefinance. She assists the firm in getting a grip on the new lending laws and regulations. She does so by researching the trends, consumer requirements, and new audience preferences. Jessica is responsible for making important financial and administrative decisions.
Apart from helping consumers with the best solutions, Jessica Williams helps them ensure financial stability. She analyse the business data, finances, expenses, and revenue/ income of customers and determines necessary changes. Jessica finished her Doctorate in finance and law and implements her knowledge to the best interest of the firm and customers.
