Should you pay off debt, invest or do both?

When you have many financial goals for your available income, you may need to choose where to focus those funds. You might debate between paying down any debt as soon as possible or using that money to invest.

Debt repayment is often prioritized, but that isn't the only approach. You also can use debt strategically depending on how it fits within your broader financial plan. Let's explore considerations to help you decide if it's better to pay off debt, invest or do both at the same time.

Some debts may be weighing you down, while some may be helping you get ahead. When thinking about the different types of debt, the biggest factor to consider is the interest rate, but it's not the only one. You also might think about why you have the debt and whether it serves a purpose.

High interest rates drive up the cost of borrowing and make holding on to debt more expensive.

• Credit cards are a good example of high-interest debt. They often charge 20% interest or higher. So, for every $1,000 you owe, you could lose $200 or more per year to interest charges if balances are not paid off monthly.
• Personal loans often charge higher interest rates, too. Rates can vary depending on your credit score and the loan terms but could easily be above 10%.

Debts with lower interest rates are more manageable because the cost of carrying a balance isn't as high.

• Mortgages can have low interest rates. Although the rate on newly issued mortgages has gone up recently, many people have mortgages with 2% to 3% rates.
• If you have a good credit score, secured personal loans also can have a low interest rate.

It's not a coincidence that "good" debt and low-interest debt are often the same, as are your "bad" and high-interest debts. It's easier to make a case for paying down high-interest, "bad" debt as quickly as possible, but you may be able to leverage low-interest debt if you could earn more on the same money if it were invested.

You also can think about why you have the debt in the first place. Some debts help you achieve your goals, while others slow your progress or even may prevent you from achieving them entirely.

An example of "good" debt that might help you is a student loan. Student loans can allow you to earn a credential that qualifies you for a better-paying job, or one with a more flexible schedule so you can spend more time with your kids.

On the other hand, consumer debt you accumulate for no real purpose doesn't help you get ahead.

Making extra payments on your low-interest debt can come with an opportunity cost, and you may need to calculate which option works best for you. These additional payments can help you get ahead and avoid paying some interest. But the tradeoff is you may miss out on earnings you could gain from investing that money instead. It all comes down to the greater incentive and how it fits into your larger financial strategy.

Say you have a student loan with a 5% interest rate. You're debating whether to pay down this low-interest debt or dedicate your money elsewhere. To help frame this decision, here are three ways you might use your money and how each compares to paying down your loan.

When you put your money in a savings account, you could earn interest on those savings. But depending on the interest rate on your debt and your savings account, you could break about even. However, you'd still have access to your money in the savings account if you needed it.

If you're considering a traditional savings account, that interest rate may be around 1%. In this scenario, you might choose paying down a 5% student loan since the savings account would earn less than what you'd pay on the loan. If you're considering a high-yield savings account with higher interest rates of around 4-5%, it may be more appealing to save the dollars to keep them liquid, especially if you're building your emergency savings.

Certificates of deposit (CDs) and other fixed-rate investments are another option. You may be able to earn a higher interest rate than you're paying on your debt, but the money is locked up until the security matures. This can make sense if short-term liquidity isn't a concern and you're saving for a midterm goal, like buying a car in a few years.

You may earn more with a CD than with a traditional savings account, possibly up to 5%, but you may earn less than you'd pay on your student loan. This choice balances liquidity with the desire to maximize your interest. Thrivent Credit Union often runs earnings specials on short-term CDs. See if one may fit into your financial strategy.

If you invest in mutual funds, the return you receive could be higher than the interest you save on paying your loan, especially over longer periods of time. However, make sure you understand the risk and potential for volatility. When compared to a student loan at 5%, most equity mutual funds likely grow at a faster rate. However, you could see big swings from year to year with low or even negative returns. Only choose this option if your horizon is at least 5 years or more depending on the share class purchased. This time frame could be extended.

Yes, you could do both. Decide on your split by comparing your budget with your debt and investing priorities.

For example, suppose you have $300 per month to spend and one small debt you want to pay down. You may decide to put an extra $100 toward the debt and invest $200. Or if the balance is larger, you might decide to put $200 toward the debt to pay it down more quickly and invest the other $100.

Mixed race woman paying bills on laptop

How much is your debt costing you?

Whether you choose to pay off debt or invest, each has its tradeoffs. It's just a matter of which calculation wins out. See how much your low-interest debt could cost you in the long run with our snowball debt calculator.

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These calculations are just one side of the coin. Your debt payoff decisions aren't only about math—your priorities may be more firmly rooted around other variables, and that's OK.

For example, your debt, even if it's the "good" kind, may cause more financial anxiety than you're comfortable with. Or you may prefer to prioritize a specific debt payment, like paying off a car loan so you can gift it to your kids or to someone who needs help. Paying down that debt could be more worthwhile to you than capitalizing on a higher interest rate in a savings account.

On the other hand, you may have a particular savings target in mind that would let you change jobs, buy a house closer to work, or feel more confident in your retirement plan. If achieving these goals lets you lead a more fulfilling life, you might pursue them instead of paying down your low-interest debt.

Your decision should lie in your goals and how your choice directly affects your ability to achieve them. Talk through all the possibilities with a Thrivent financial advisor. They can help you visualize each strategy and see whether paying down debt, investing more, or a combination of both is the best move for your financial plan.