Pay off debt? or Not? that is the question

It’s been on my mind a bit over the last few days and I’m not sure what the best thing to do is.  Let me know what you think is the best thing to do…

I currently don’t own a vehicle which isn’t such a big deal since everything I need is within walking distance of my apartment and it is great not having that extra expense of gas/insurance/car loan.  But I have wanted to get a motorcycle for the last 3  years so that I could get out of the city more easily, and have more options for things to do on the weekend.

my balance sheet currently includes about $13000 in debt.  About half of that is my student loan which is at prime + 1.5% (I think) and the other half is on a line of credit at about 11%.  At the same time I have about $16000 in an unregistered investment account.  The performance of the stocks has been really good in the last few months and so I’d like to hold on to them as the markets recover over the next year, but at the same time cashing out would allow me to completely pay off all my debts which would give me approximately $500/month in extra cash flow.

It’s a tough call.

On the one hand, the value of the stocks will seems guaranteed out pace the interest charges on my loans this year – in fact they’re already up over 20% YTD.  So in terms of net value there’s a good chance I would be better off holding onto the investments.  But of course there is uncertainty and risk in holding onto those stocks and maintaining the debt.

On the other hand, liquidating the stocks would give me a guaranteed extra cash flow of $500/month which would be enough to finance the motorcycle I’ve been dreaming about for years AND increase my monthly savings.  wiping out the debt and stock market exposure would reduce my risk, but also limit my potential capital gains should the economy continue to recover.

The third option of selling half my investments and paying off the higher cost line of credit isn’t really appealing to me. I’d get an extra $200/month in cash flow but it would not be enough to offset the cost of getting a motorcycle before this summer is over.

Are there any other pros/cons to these options?  or an option that I haven’t considered?  I’m very interested in getting other people’s opinions on this.

  • Whelan

    Matt,

    Big consideration is what is the net effect of each kind of debt. For instance, you’ve got about $6500 in Student Loans, but the interest on that provides a tax credit. Reduce your payment to the bare minimum and keep the loan as long as you can to provide a tax shield.

    The secret is to eliminate whole payments, so if you can wipe out the Credit Line portion of your debt that reduces your debt servicing costs per month. Don’t think of it as payment of debt, think of it as the initial payment on an annuity that provides X amount of capital per month.

    Your other option is to take out an investment loan. Most places will give you 3:1 on any collateral you provide, so your $6000 can actually give you an investment portfolio of $24k. As long as your gains on the portfolio outpace the interest on the loan, you’re golden. (Also, the interest on an investment loan is a tax credit, giving more savings.) I think the break even on $20k over 10 years is something like 3.25% nominal… not hard to get with the right balance.