Milestone 8: Pay Off Remaining Debt
Now that you’ve reached Milestone 8 you’re in a very comfortable place financially. Take a look at how far you’ve come:
- Starting Point: Creating Your First Budget
- Milestone 1: The Uh-Oh Fund
- Milestone 2: Take Advantage of Your Employer Match
- Milestone 3: Pay Off Toxic Debt
- Milestone 4: Fully Funded Emergency Fund
- Milestone 5: Save 15%-25% of Your Income in Tax-Advantaged Retirement Accounts
- Milestone 6: Invest for Flexibility
- Milestone 7: Prefund Kids’ Expenses
- Milestone 8: Pay Off Any Remaining Debt
- Milestone 9: Total Financial Independence
Back at Milestone 3, we covered the importance of paying off “toxic” debts which we characterized as just about everything short of low-interest debts like mortgages or student loans.
Once again, the roadmap has been set up for the optimal financial series of decisions, but there are exceptions. If you’ve illustrated the financial maturity to reach Milestone 8, you’ve also made it to a place where you can enjoy significant financial flexibility.
As we started suggesting in Milestone 6, don’t be afraid to arrange milestones 6 through 8 in a way that best suits you.
With that said, just because you can afford debt at this point in your life doesn’t mean it’s a great idea. Let’s look into this a bit further.
Debt Recap
When we covered Toxic Debt at Milestone 3, I walked through four debt quadrants that are in the graph below and explained in the subsequent bullet points.
Four Debt Quadrants:
Secured/Appreciating – Okay If Affordable – Example: Mortgage
This is the safest and wisest form of debt because having a secured asset that appreciates should allow you to find low interest rates and provide the financial benefit of capital appreciation in the asset that debt is used to buy. The only way to get into trouble here is borrowing more than you can reasonably afford to pay back. But, even if that happens, you have an appreciating asset that you can sell to get yourself out of the deal.
Secured/Depreciating – Use With Great Caution – Example: Car Debt
Having collateral can make interest rates for these loans tolerable, but your overall net worth will take hit from this loan because you will lose money through 1) paying interest, and 2) the decreasing value of the asset. Over time, this can add up to hundreds of thousands, even millions of dollars. I would avoid this type of debt if possible.
Unsecured/Appreciating – Use With Caution – Example: Student Loans
The fact that these loans are unsecured places most of the risk on the lender meaning interest rates are typically higher. The good news for you as a borrower is that there is no asset in this case that can be repossessed and sold by the lender. On the other hand, there’s no asset for you to sell in order to get out of the loan, meaning you can find yourself in a great deal of trouble if you aren’t wise about borrowing money in this quadrant.
Unsecured/Depreciating – Avoid – Example: Credit Cards
This is the riskiest, least desirable form of debt for you as a borrower. Lenders cover their additional risks in this category by charging high levels of interest on the amounts they loan. Worse yet, as a debtor in this quadrant, you won’t be able to sell the assets you purchased with the borrowed money, making it difficult to pay off the loan if you’re strapped for cash. Stay away.
I’m going to assume from here on out that you’ve complied with the standards of Milestone 3 and no longer have any toxic debt.
Should you happen to have any debt at this point, it should have an interest rate that is lower than the rate for a treasury security issued for a similar period as your debt or, it should be a mortgage on your primary residence.
If you have debts that don’t meet these two criteria, then you should pay them off.
I really can’t think of a good reason to carry high-interest debt on depreciating assets at this stage in your financial life. It just doesn’t make sense.
With that out of the way, let’s look at the case for paying off your remaining debts versus continuing to carry them
The Case for Continuing to Hold Debt
Making the case for continuing to carry debt is relatively simple because it’s based on math.
If you have debt in a financial stage where you have 3-6 months of expenses saved, you’re investing 15%-25% of your income, you’re saving for your kid’s college education, etc., then it’s probably because the interest rate was too good to pass up.
And by “too good to pass up”, I mean lower than the amount of interest you can reasonably expect to receive from investing the money you could direct toward the debt instead.
For example, as I was writing this in late 2024 the current yield for a 20-year treasury bond is 4.465%.
Just a few years ago, it wasn’t all that uncommon for people to secure a 30-year mortgage at 3%.
That difference may not seem like much, but if you invested $1,000 per month for 20 years at 4.465% instead of paying down a mortgage at 3%, you’d come out $44,501.84 better off thanks to compounding interest.
The risk is relatively low either way, but if you’re the type of person who prefers mathematical efficiency over being debt-free, then this is the case for you.
Now, let me challenge this idea a bit by providing a mathematical reason to just pay it off.
The Case for Paying Off All Remaining Debt
In 2024, the average monthly mortgage payment in the United States is $2,400.
That’s $28,800 each year focused on paying off a debt.
That’s also $28,800 that most Americans will need to realize in taxable income (be it from a job or retirement accounts) to make monthly mortgage payments.
Here is what $28,800 costs the average American in taxes based on a variety of marginal tax rates:
Now, imagine that you’re in a position to control the amount of realized income you receive each year, like when you’re retired.
Depending on your marginal tax rate, not having to withdraw another $28,800 each year would save you some portion of the amounts listed in this table because you wouldn’t need to realize that income to pay your mortgage.
Of course, this doesn’t include any credit for interest deductions if you do itemize, but it is something to think about.
To make the optimal mathematical decision, you’ll have to make some basic assumptions and run the numbers yourself.
The Case for Doing Whatever You Want
Again, given the financial flexibility you enjoy at this stage on your financial journey, the fact is paying off low-interest debts or deciding to continue carrying them is not going to make a huge difference either way.
If you know you have an incredible interest rate on your mortgage but think you’ll sleep better at night being debt-free, then you should just pay it off.
On the other hand, if you just have to follow the path of mathematical efficiency, then keep making those minimum payments and invest the rest.
I won’t say that you can’t screw it up at this point, much your margin of error is much wider than it would be in the earlier milestones.
In the final post of the Next Dollar Roadmap, Milestone 9: Total Financial Independence, we’ll talk more about ways to preserve, protect, and give effectively from your wealth.
