Pay Off Debts First to Improve Your Financial Security … With Exceptions
When people are asked what they want to do after they’ve won the lottery, a traditional answer usually involves paying off debt first – and often doing so before spending, investing, or fully analyzing the full extent of their newfound wealth. Most of the time, this is a great idea. But sometimes, it may not be the most financially efficient way to deal with the situation.
In many cases, you may lose out on potential profits if you spend a lot of cash immediately to pay off your debt, but this depends on a variety of factors, including interest rates and fees. Therefore, you should always take a close look at the nature of your debts (and your overall financial strategy) before making the decision to pay off large loans.
If you’ve won the lottery, one of the first steps you should take is to sit down with professionals, including an accountant, a financial advisor, and lawyer, to examine your new financial situation and how different choices you make now will impact your finances in the future. During this process, it’s important to see exactly how much debt you have, how much you now have in cash, and how much you plan to get through future income and any future lottery payments or disbursements.
While going through your finances, it’s also essential to look at how any decisions you’ll make, including paying off debts, will affect your tax burden. In many cases, when someone has a high net worth, routine financial transactions can cost individuals in the form of extra tax payments if they’re not careful.
There are some debts you should pay before making a full game plan. Debts like those from unpaid credit card bills or utility bills, any unpaid government fines, fees, or other expenses should usually be paid off right away. One of the best arguments for paying these debts off fast is because they usually have high interest rates, which means that each day you wait could cost you significantly. Additionally, if you count bills and/or fines from courts or the government among your debts, leaving these unpaid could even result in trouble with the law.
Overall, paying off these debts can often save you serious headaches in both the short and long term. So, unless they’re particularly large or there are extenuating circumstances, such as a legal judgement against you that you plan to appeal, you should probably pay them off as soon as you can.
Despite the fact that some types of debt should be paid off right away, others may be able to wait. For example, most mortgages and many student loans, especially those issued by the government, have relatively low interest rates and fees, often around 3-6% percent and sometimes even less. Currently, the average US mortgage rate is 4.125%, and many financial experts suggest that Instead of paying off these loans, you may want to consider using this money to invest in stocks, bonds, mutual funds, CDs or money market accounts.
In many cases, relatively stable investments like mutual funds can gain an average of 8-10% a year, and sometimes much more, well outpacing the amount of money you would lose paying interest on your loans. If you want to determine just how much you might be able to make by investing instead of paying off loans right away, take the difference between the rate that you could get from your investment and the rate you pay in interest. These are the potential profits you could lose out on if you pay off your loans first.
For example, if your mortgage has a 3% interest rate and you can get 9% return from a mutual fund, you’re losing out on 6% return by paying off your loans first. Of course, it’s important to realize that no investment in stocks, bonds, or mutual funds is guaranteed (and prices can fluctuate wildly with the market), but the chance of getting a decent rate of return is a pretty good one, especially if you invest in a low-to-moderate risk mutual or index fund with a good reputation and low fees.
By now, you’ve likely realized that immediately paying off a mortgage or student loan debt may not be the most efficient financial decision, especially if you’re planning to invest your money. However, unless you’ve only come into a small amount of money and you’re really loaded down with debt, paying off debts first shouldn’t negatively impact your overall financial situation.
In the end, many people simply like the peace of mind that comes from knowing you have no mortgage or student loans – and peace of mind is more important than a minor gain on your investments. Plus, if you want to reduce your loans while still having more money to invest, you can always pay off a chunk of your mortgage or student loans right now, allowing you to pay off the rest of your debt more quickly. This may be the best of both worlds, as you can have a significantly reduced debt load while still making smarter use of your money elsewhere.
If you’ve recently come into a lot of money, making the right financial decisions can be a confusing ordeal. Jumping a couple of tax brackets overnight means that nearly everything you do now has tax implications – and it’s all too easy to make a mistake that could cost you thousands or millions down the line. The lesson: do your research and consult an expert before making decisions that could seriously affect your financial future.
To learn more about customized disbursements and ways that lottery winners and others can protect, maintain, and grow their newfound wealth contact the experts at NuPoint Funding today for a free consultation.