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Save for Retirement vs Pay Off Debt vs Buy a House – Which is the Best

Are you confused on the best retirement plan to choose? If YES, here is a detailed comparison between saving for retirement vs paying off debt vs buying a house.

If we aim to live a better life, then we have a lot of choices to make. Some are simple choices on how we can live our day to day lives comfortably, and others are more complex. Trying to decide whether to buy a house or to start saving for retirement when we have a pile of debt to our name is one of the more complex decisions we have to make if we are to avoid regrets later in life.

The majority of Americans leave school not only with their certificates, but with a pile of debt in tow. With school debt still in the burner, some people also rack up credit card bills, car loans and the like, thus further keeping them knee deep in debt. A lot of people cannot be blamed for this because sometimes debt is a necessity of life. After all, paying cash for a house, an education, or even a car is out of the reach of most families, so borrowing is the next viable option.

The older you get, the more other facts of life start creeping up on you, like buying a house and saving for retirement. The question now is, if you have debts to pay off, but you also need to buy a house, while also noticing that retirement is not far off in the horizon, and you need to start getting ready; which do you do first?

Retirement Plan 1 – Saving for Retirement

Retirement is a fact of life, because we would all get old someday and have to stop working. Even if we are still strong enough to continue working, but the law mandates us to stop at a certain age. Even if you run a business, you would still have to retire at a certain age. The mistake most young people make is to think that retirement is still far off and as such still keep retirement savings as a future project.

Research has made it clear that for you to achieve your ideal retirement nest egg; you need to start early enough. Putting in a little frequently may prove to be a better idea than planning to save in bulk on a later date. If you have access to a 401(k) at work and your employer matches contributions, you may have to prioritize investing at least enough money to get the match. In this way, your employer is helping you grow your retirement savings.

Another advantage of investing in a 401(k) or IRA, is that you get tax breaks for investing. These tax benefits essentially provide a guaranteed return on your investment because you reduce your tax bill. If you made $5,500 in IRA contributions and were in the 22% tax bracket, you would save as much as $1,210 on your taxes.

Putting off saving for retirement until you are debt-free could cost you your most valuable asset: time. With compounding interest, even small contributions to your retirement plan can grow significantly.

If you wait to pay off your debt before saving for retirement but then you never manage to pay off the debt, one day you may realize that it is now time to retire and you are completely unprepared; and you even may be still in debt. Believe me, a lot of people are in this position.

The IRS puts limits on how much you can contribute to tax-advantaged retirement accounts every year. If you don’t take advantage of contributing up to that limit, you would lose that opportunity  in fact, forever.  This, combined with the fact that delaying investing means you lose time to grow your investments, is a compelling reason to save for retirement even if you have some debt still lurking around.

Again, if you work in a place where your employer contributes a percentage to your retirement plan, then it makes so much sense to take advantage of such plan. If your employer will match 50 percent of your contributions up to six percent of your pay, then you should contribute six percent to max out the employer match.

But even if this type of contribution is putting the squeeze on your budget, you can always opt to contribute four percent of your pay, to get a two percent employer match, or even contribute two percent of your pay to get a one percent employer match. If you can do this while prioritizing paying off debt, you’ll come out ahead in the end.

Retirement Plan 2 – Paying Off Debt

If you’re in a substantial amount of debt right now, then you know the emotional toll it takes. You spend time worrying about how you are going to pay your bills and meet your budget every month, let alone trying to get ahead. You may even lose sleep over the state of your finances. By getting out of debt, you will free up your mind and your emotions to freely concentrate on moving forward in life.

On a more tangible level, once you’re out of debt, you will not only have more control of your finances, but you’ll have more free cash to direct to retirement savings and other investments. Paying off your debt may be the best way to maximize your retirement contributions, at least at a later date. When you are paying off your debts, you can even tell yourself that you’re doing this to help prepare yourself for retirement.

Understand that, while the terms of any loan arrangement are fixed, the results of investment activity are not. Stocks can fluctuate in value, but debt doesn’t. That is to say that there is a fundamental imbalance between debt and investments.

Worst-case scenario: while you are prioritizing retirement contributions over paying off debt, the stock market crashes and 40 percent of your retirement assets are wiped out. But what happens to your debt in that scenario? Nothing—you still owe as much on your debt after the crash as you did before.

In that way, paying off debt is a guaranteed investment. It not only eliminates the interest expense that the debt carries, but it also guarantees improvement in your future cash flow.

How to Pay Off Debt Easily

If you are looking for an easy way out from your debts, you can try debt consolidation. By debt consolidation, it means putting your various debts together in one portfolio. You can do this a couple of different ways: A balance transfer, a debt consolidation loan, or a home equity loan or line of credit.

A balance transfer involves transferring your debt (let’s say, credit card debt) to a o percent APR balance transfer credit card. This is the way to go if you can pay off all your debt during the 0 percent APR promotional period (usually between 15 and 18 months).

A debt consolidation loan is exactly what it sounds like: A loan with the express purpose of paying down debt. Personal loans are a good option because you don’t have to put down any collateral and you can choose from a range of repayment periods and rates.

Finally, a home equity loan or line of credit can help you pay off debt, but only if you own a home. You can use the equity you’ve built up on your home to secure a loan or line of credit to use for debt consolidation. However, this is our least recommended way to pay off debt, since it involves putting up your home as collateral.

Retirement Plan 3 – Buying a House

Buying a house can be really exciting, and the excitement doesn’t even dim with the realization that you would be getting into debt because of that. After all, you are only trying to secure your future. But the fact remains that buying a house would make you to start paying a mortgage, and this payment can last anywhere between 10 to 30 years.

But besides the social privileges and freedom a home embodies, it also represents a very real material asset that can help fuel future dreams and aspirations. Other advantages of buying a house include:

  • Tax benefits

As a homeowner, you get to deduct both mortgage interest (up to $1 million) and property taxes from your annual income taxes. So, owning a home can reduce the amount you pay in income taxes each year. Your mortgage interest and property tax payments may be deductible from your federal taxes, as well as many state taxes. Certain closing costs and loan discount points also may be tax deductible. If you’re a new homeowner, you enjoy even more benefits because most of the money you pay on your mortgage goes to interest.

  • Price appreciation

Houses generally go up in value over time. In general, most homes will see their value increase as time goes on. If you purchase your home for $150,000 and the annual appreciation rate is about 3%, in 30 years your home will be worth $449,043. That is an incredible increase in the value of your home, thus making it a great investment on your part.

  • You get to strengthen your credit

When you buy a home and consistently make your monthly loan payments on time, it demonstrates to other lenders that you are a good borrower and the risk of you defaulting on a loan is low. As your credit score grows, you open up the door to better loan terms and interest rates on your future purchases.

  • Consistent Budget

When you purchase your home, you will know exactly what your payment will be if you choose to go with a fixed-rate amortized mortgage for the lifetime of your home loan. You can set a consistent budget for your home loan. When you know what to expect, it makes it a lot easier to budget and to save money.

  • You earn profits when you decide to sell

When you own a home, the value of your home gets to increase with time. If at any point in time you decide you want to move on, you can sell your home for a lot of profit. If you live in a rental house and the owner decides to sell, you walk away with nothing, and you may even be stranded. The longer you are a homeowner, the better it is for you, and the higher your profits will be.

All these and more show that buying a house has both long and short term benefits. But the question still remains, should you buy a house instead of paying off your other debts or saving for retirement.

Save for Retirement vs Pay Off Debt vs Buy a House – Which is the Best

There is no denying the fact that you would need a lot of time to turn your retirement savings into a much bigger nest egg, thanks to investment returns compounding upon themselves. That means delaying retirement savings is a bad idea. But letting debt rack up interest charges for you while you send precious dollars to your retirement account doesn’t make a lot of sense, either.

On the other hand, some people may decide that it would be more to their advantage if they just get a house in spite of everything considering all the advantages that comes with buying a house.

If you are asking this kind of question, that means you are owing quite a few people or organizations; you are yet to start off a retirement plan, or you may have it and want to keep it at the back burner; while considering buying a house.

  • Retirement Savings Should Come First

Having considered all variables, we have decided that it is more logical to save up for retirement first before any other thing. This is because it would take a whole lot of savings to catch up if you typically ignore this aspect now. A retirement plan should be as much a part of the budget as your rent, car, cellphone and cable. Debt may come or go, but retirement is a part of your life, and if you do not prepare adequately for it, you would lose in the end.

Like was said before, if your employer offers a matching contribution to a 401(k) or other retirement savings plan, contribute as much as it takes to get that free money. If you don’t have a retirement plan at work, open a traditional IRA or Roth IRA.

You can set up recurring transfers from your bank account to mimic the ease of an automated workplace contribution. The bottom line here is that you must have a retirement plan going on no matter how small you choose to contribute in the meantime considering your other expenses.

  • Paying off high-rate debt should be your next priority

If you have got credit card debt, payday loans, or debt that has variable or high interest rates — anything that is about 9% — you need to tackle that next before thinking of adding another debt in form of mortgage to your stress.

You can focus payoff efforts on your smallest debt first, while always making the minimum payments on the others, of course. Once that’s paid off, focus on the next debt, and so on. You can equally start with the biggest debts and work your way down, whichever method suits you best.

Dedicating extra money toward repaying high-interest consumer debt could leave you financially better off, even if this early repayment delays your efforts to save and invest for retirement or other financial goals.

If you have payday loans — short-term loans intended to last until payday that often have interest rates above 300% — it’s imperative to focus on paying those off first before investing. Payday loans, and other predatory loans such as car title loans, are so expensive, they’re designed to force you to continue borrowing forever, so paying them off as soon as possible should be your top priority.

On the other hand, you have to know that debts such as mortgages, car loans and personal loans sometimes impose penalties if you repay too early. If that’s the case, aggressively paying down these debts often makes little or no sense because much of the money you save on interest is lost when you decide to pay this penalty. So when deciding whether to pay off debt early, you’ll also need to factor in any prepayment penalties you might owe.

This goes to show that there are debts that should be tackled quickly while there are others that can run concurrently with your other projects. The kind of debt you owe would determine your priority in this matter.

  • Then Mortgage

Once you have reduced your debt burden substantially, you can now start thinking of taking on a mortgage. While buying a house comes with loads of merits, but you should understand that getting a mortgage plunges you into more debt. It might be a great idea to put off buying a house till such a time when you are free of debt or when your debt portfolio is quite reasonable and you can handle it with every other thing.

Note: When setting financial goals, you don’t have to allocate all of your extra money toward becoming debt-free, nor do you have to put all of your money toward retirement. You can divide up your extra money and address both. If you are paying off the debt and simultaneously saving for retirement, you would end up on stronger footing than you otherwise would be.

Dividing your efforts can make it harder to score wins and maintain momentum because you won’t get your debt paid off as fast, or hit retirement or mortgage milestones as quickly. But you can get around these problems by taking steps such as automating debt payments and automating contributions to investment and savings accounts. If payments are automated, you won’t have to make the choice to do the right thing every month.