Financial Model to Help Decide to Pay Off All Debt or Invest That Money Instead

This is something individuals and businesses alike often think about when deciding what is the most financially sound thing to do. Anybody that has ever had a loan has come across this decision to some degree. You will see the logic can get complex when actually trying to build something that shows an accurate apples to apples comparison.

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Assuming you have enough cash to pay off all your debt, should you do that or should you take that same money and invest it somewhere else and just keep paying off your debt each month rather than being debt free now.

There are a lot of things at play here and the financial model being presented to you here was made to basically show a race between the scenarios. It is basically showing you which scenario results in a net higher investment amount once all the debt is paid off.

Assumptions:
  • This looks through the lens of someone that wants to make an investment and has loans. Paying off the loan now means less money to invest, but more monthly cash flows that can be invested in the future and paying off the loans over time means more money to invest now but less cash flow to contribute over time. So, what is the best decision?
  • The debt service you use to pay off the loans over time is assumed to be cash you can invest now in the scenario where you just paid off all your debt. The thinking here is that if you would have to come up with that monthly debt service anyhow, it should still be available for investment in the scenario where you just paid off all your debt. So, instead of paying off your monthly bill, you have no bill in that scenario and it is just free cash flow available to invest.
  • The 'investment' that is being measured against will assume monthly compounding interest at an annual rate of return (not to be confused with APY).
  • Once the debt is fully paid off, the initial debt service amount is no longer assumed to be contributed.
  • In the scenario where you pay off the debt over time, you do get to assume the extra debt service from a loan that has been paid off in the course of time can now be contributed in the same way that the entire debt service is contributed to the pay off debt now scenario.
  • Enter starting cash available, cash kept for reserve, all loan details (remaining balances and remaining term), and then the cash available after your reserve is accounted for will either all go to an investment while you pay off your debt over time or it will all go to the loans now and you can then contribute the future debt service amount to your investment now.
At a high level, this all boils down to the current annual rate of return you think you can get on an investment now compared to the total debt service. You can't just look at the interest rates on the debt because the term and current balances will also play a part when you are trying to make a forecast on what is better to do.

For example, if you have loans with say a 5% rate and have 30 years to go while having a current investment that pays 3% annual returns, it could still be better to pay off all the loans now and take the 3% annual rate because of the effect that the debt service will have on your ability to contribute to the investment over time. In that case, you are looking at the total debt instead of just the interest rate on the debt. It is important when trying to make a valid comparison on what to do.

You can plug in up to 5 loans.