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
> 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?
Because you don’t need to spend the whole $100k to pay off the $10k loan. The full $100k is not at issue, just the $10k
Think of it in two buckets… $10k + $90k
The $90k is going to earn you $7,200 regardless. So, just ignore it
On the other hand if you don’t pay off your 12% loan the additional $10k in capital will earn you $800 but you will $1200 in interest, netting a negative $400
Altogether this means you’ll earn $6800
Whereas if you pay off the 12% loan you won’t earn the $800 in interest on that $10k of capital you preserved, but you also won’t pay the $1200 interest on the loan, so overall you will net $7200
The amount of capital you have above the amount of the loan is completely separate and does not factor in at all
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