I am not sure exactly how to phrase this question but it is one that I’ve been curious about for a while. Tons of people in finance always are okay with debt at low interest rates but are quick to pay off high interest debt. Why don’t people take the amount of capital into consideration? Example: I have $10k of debt at 12% interest but have 100k invested earning 8%. Despite me earning a lower APY on my investment in comparison to the APR on the debt, I am still earning more money annually. That 100k will be $8k earned after the year at 8% but the debt will only lose me $1200. So why would one be quick to pay off high interest debt if it’s a lower principal compared to having a higher principal at a lower rate?
In: Economics
In your example, you’re comparing different volumes – which means you’re comparing an orange to a watermelon. You should be comparing an orange to an apple (something of similar size).
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You have $10k debt and pay $1200 a year.
You have $100k making $8k a year.
1. You should look at this as you have $90k making $7200/yr
2. And you have $10k making $800/yr.
So the question is, do you want to spend #2 to make $800 so that it can be used to pay the $1200 interest, thereby you would still owe $400?
Or would ya rather use #2 entire balance of $10k and pay off the debt?
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The simplest way to look at money is by %. There’s percent going out (which is debt) in this case it’s 12%, then there’s percent going in (which is investment/profit) in this case it’s 8%. Since the percent is higher than going in, then you should focus on removing it.
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