When we have a little extra money we often struggle with whether to pay down debt or invest the money. The question comes down to this: If you can earn a higher after-tax return on your investments than the after-tax interest rate expense on your debt, you should invest. Otherwise, you should pay off your balance. Keep in mind that there are two different types of debt: high interest credit card debt and low interest mortgage and student loans that may have tax deductions. Most investments won’t outstrip the high interest paid on credit cards, but some investments may yield higher returns than interest that is associated with tax deductions. The 2012 long-term return on equities is somewhere around 8%*. Let’s look at a few scenarios :

Debt 1: Mortgage
• Term: 30 year
• Amount: $170,000
• Your tax bracket: 25%
• Pre-tax mortgage rate: 6%
• After tax mortgage rate: 4.02%

Debt 2: Credit Card
• Balance: $10,000
• APR: 22%
So if you have debt like the mortgage above, then investing the money makes sense. You can expect almost a 4% gain from the investment overall. If you have debt like the credit card above, you should probably pay off the debt. No current investment will come close to the 22% interest rate you are getting charged. Try using the following calculator to figure out what makes sense for your situation.
* Source: Kaser, Richard. “Stocks: Why Investors Can Still Expect 8% Long Term” Kiplinger. 26 April 2010. Web 22 June 2012