Debt vs Investment

Should you clear debt or invest spare money? The answer depends entirely on the interest rate on your debt compared to the returns you'd expect from investing. This isn't a moral question. It's mathematics.

Debt at 20% interest costs you more than investments returning 7% would earn you. Clear that debt first—it's effectively a guaranteed 20% return. Mortgage debt at 2%? You might be better off investing, because long-term investment returns typically exceed 2%. The interest rate determines the priority.

High-Interest Debt: Clear It

Credit cards at 20%+, payday loans, store cards, overdrafts. This debt is expensive. You cannot reliably earn returns that beat these interest rates. Paying off a 22% credit card is a guaranteed 22% return on that money—far better than any investment.

If you've got £5,000 in credit card debt at 22%, that's costing you £1,100 annually in interest. Every pound you use to clear it saves you 22p yearly forever. That's a better use of money than investing it hoping for 7% returns.

Ignore people who say you should invest while carrying high-interest debt because "you need to build wealth." Carrying 20% debt while trying to invest is burning money. Clear expensive debt first. Then build wealth. (See The Priority Timeline for the complete order of financial priorities.)

Low-Interest Debt: Maybe Keep It

Mortgages at 2-4%, student loans at 5-6%, car finance at 3%. The case for clearing these early is weaker. If your mortgage charges 3% and you can invest and earn 6-7% long-term, mathematically you're better off investing. (Understanding the risk involved requires grasping time horizons and volatility—covered in The ISA Wrapper & Understanding Risk.)

But this isn't purely mathematical. There's psychological value in being debt-free. Reduced financial stress, greater flexibility, the security of owning your home. Some people prioritise this over optimal returns, and that's valid. Money isn't only about maximising numbers—it's about building a life that feels secure.

If you can't sleep at night knowing you have a mortgage, pay it off even if investing would be better financially. Peace of mind has value. But make it a conscious decision, understanding the trade-off.

Student Loans: A Special Case

Student loans aren't like other debt. You only repay when earning above a threshold (£27,295 for Plan 2, £24,990 for Plan 1). Repayments are 9% of income above the threshold. After 30-40 years, whatever remains gets written off.

For most people, trying to pay off student loans early is financially foolish. You're better off investing that money or paying into pensions. The interest rate doesn't matter if you're never going to pay off the full balance anyway—and most people won't.

The exception: if you're a very high earner likely to clear the balance within the 30-year period, and your interest rate exceeds what you'd earn investing, then maybe early repayment makes sense. For everyone else, treat student loan repayments as a graduate tax and ignore them beyond the automatic deductions.

The Mortgage Overpayment Debate

Should you overpay your mortgage or invest the money instead? This is one of the most common financial questions, and the answer is genuinely personal.

The case for overpaying: You're guaranteed to save the interest you would have paid. If your mortgage is at 4%, overpaying gives you a guaranteed 4% return. You'll own your home sooner. Reduced financial stress. Greater flexibility once it's paid off.

The case for investing instead: Long-term stock market returns historically average 5-7%, exceeding most mortgage rates. Your money has more growth potential in investments. Mortgages are cheap debt—use it to free up money for better uses.

Both positions are defensible. Which is right depends on your mortgage rate, your risk tolerance, your other financial goals, and how much you value being mortgage-free.

The Opportunity Cost of Debt Repayment

Every pound you use to repay debt is a pound you can't invest. The younger you are, the bigger this trade-off. A 30-year-old using spare money to clear a 3% mortgage isn't investing that money during their peak compounding years. That's expensive in terms of lost investment growth.

A 55-year-old doing the same is closer to retirement. They have less time for investments to grow. Clearing the mortgage might give them a debt-free retirement, which has real value when income drops.

Time horizon affects the debt vs investment decision. Younger people usually benefit more from investing. Older people approaching retirement often benefit more from clearing debt. But it's not absolute—circumstances vary.

What About the Emergency Fund?

Before aggressively clearing any debt or investing heavily, build an emergency fund. Three to six months of essential expenses, accessible in cash. This protects you from having to take on new expensive debt when life goes wrong. (See The Priority Timeline for why this comes first.)

Without emergency reserves, you end up clearing credit card debt, then having a car breakdown and putting it back on the credit card because you've got no other option. You're running to stand still. Emergency fund first, then tackle debt and investment decisions.

The Emotional Weight of Debt

Debt causes stress. Even low-interest debt. Some people can't focus on building wealth while carrying any debt—the psychological burden is too heavy. If that's you, prioritise clearing debt even if it's not mathematically optimal. Mental health and financial security are linked.

But recognise this is an emotional decision, not a financial one. You're choosing peace of mind over maximum returns. That's fine. Just be honest about what you're prioritising.

Conversely, some people are comfortable carrying low-interest debt indefinitely. They can separate the emotional from the financial. If you're genuinely comfortable with a 3% mortgage, and investing the money instead makes financial sense, do that.

Good Debt vs Bad Debt

Some people distinguish between "good debt" (mortgage, business loans, student loans) and "bad debt" (credit cards, payday loans). The idea is that good debt funds assets or income growth, while bad debt funds consumption.

This distinction is less useful than focusing on interest rates and terms. A mortgage at 2% is manageable. A mortgage at 8% is expensive. It's the same debt type but very different financial impact.

Student loans fund education that might increase earning potential—"good debt" in theory. But if you graduate with £50,000 debt and don't increase earnings, was it good? The outcome determines the value, not the category.

Focus on interest rates and whether the debt is funding something that improves your financial position. That's more useful than labeling debt good or bad based on its source.

Paying Off Debt While Building Pensions

The one debt payment that should almost never stop is pension contributions, especially if there's an employer match. The employer contribution plus tax relief is too valuable to sacrifice, even while clearing debt.

If you're carrying expensive debt and contributing above the minimum to capture employer match, consider temporarily reducing pension contributions to clear the debt faster. But never drop below the level that gets full employer match—that's leaving free money on the table.

The Snowball vs Avalanche Method

If you've got multiple debts to clear, you need a strategy:

Avalanche method: Pay off highest interest rate debt first, regardless of balance. Mathematically optimal—saves the most on interest.

Snowball method: Pay off smallest balance first, regardless of interest rate. Psychologically powerful—quick wins maintain motivation.

Avalanche saves more money. Snowball keeps you going. For most people, snowball works better because motivation matters more than optimal mathematics. You need to sustain the effort for months or years. Pick the method you'll actually stick with.

When to Stop Clearing Debt and Start Investing

Once high-interest debt is gone (anything above 7-8%), shift focus to building wealth. Keep paying off lower-interest debt at minimum required amounts, but start investing spare money instead of overpaying.

The goal isn't zero debt. It's manageable debt at reasonable rates, combined with growing assets. Being mortgage-free but with no pension or savings isn't financial security. Having a small mortgage but £300,000 in pensions and investments is.

Wealth isn't about owing nothing. It's about having assets that exceed debts by a meaningful margin, and income sources that support your life. Debt is a tool. Use it wisely, pay the expensive stuff off quickly, and don't let fear of debt prevent you from building long-term wealth.