One of the most common retirement planning questions is what should be done with debts, both consumer debts and large debts like mortgages or car loans. The answer is simple: pay off as many as possible.
Financial planners recommend paying off all debts before entering retirement. The reason is simple: the interest rate you pay on a credit card, mortgage, or car loan is often higher than what you can safely earn investing your money in a combination of stocks and fixed income investments. Therefore, by carrying debt, you are paying a higher interest rate to invest money into a portfolio with a lower rate of return. You might be borrowing at 15% from a credit card, for example, in order to invest in a portfolio that might earn only 7% per year.
Paying off credit cards before retirement is an absolute necessity. For one, the rate of interest you pay on a credit card is much higher than any kind of financing. Secondly, credit card balances have a short amortization period, meaning that the cash flow requirements of a credit card are much higher than the cash flow necessary to fund a mortgage of a similar size. For each $1,000 in credit card debt, you’ll need a minimum of $30 per month just to make minimum payments.
Always pay off quickly amortizing, high interest rate loans before reaching for retirement. That means credit card and car loan debt should be the first to go, while a mortgage on a home in which you live is much more tolerable as it requires less cash and costs less in annual interest expenses.