Sunday, June 20, 2021
Khaleej Times - What should you do with windfall gratuity gains: Invest or pay off loans?
Vijay Valecha , Special to Khaleej Times June 20, 2021
The Covid-19 pandemic has forced a lot of us to re-examine our finances.
With uncertainty looming large over jobs and pay cuts disrupting harmonious monthly household budgets, there is always a question of whether to continue funding retirement savings or clear off debt first.
A debt-free living mostly affords more opportunities and possibilities, but then there is also the temptation to leverage low interest rates during such times to build assets.
Where does one draw the fine line and how should one go about making financial decisions that we are happy about in the long run?
Prioritising paying off debt as opposed to saving for retirement depends on several factors such as: debt to income (DTI) ratio, current retirement savings, and types of loans taken.
Another important factor to consider is the type of debt and interest rate charged on it. “Pay off the most expensive debt first — rather than trying to reduce the number of loans. Also, check the cost of early payment. Know if there are any penalties associated with early foreclosure, so that the total cost is correctly measured,” said Vishal Dhawan, a certified financial planner and Chief Executive Officer (CEO) of Plan Ahead.
So, what kind of a loan must be paid off first?
Credit card debt must always be cleared first, especially if you are simply paying the minimum amount every month. An outstanding of Dh10,000 can take more than a decade to clear off the loan and you will end up paying the bank or the financial institution about 2.7 times more than the original sum.
Conversely, automobile and payday loans and credit card debt are constituents of bad debt. Plastic debt can ruin financial health and the interest rates are killer.
Moreover, the hidden fee is present in card loans, which naïve investors are unaware of. Automobile loans may not have the highest interest rate, but the value of the vehicle depreciates quickly and is thus considered as a bad debt unless the vehicle is a necessity and not luxury.
The bottom line is, if an investor is still a mile away from retirement and has low interest rate debt to pay off, he or she may choose to park his/her money towards a monthly systematic investment plan (SIP) in equity markets so that high returns are generated. The idea is to exploit the time value of longer-term investments along with the ability to take risks while h/she can afford to.