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Friday, April 28, 2017

The Emotional Part of Paying Off Debt

Posted by Tim Stobbs on November 30, 2006

I recent had a conversation with a friend who had a nice problem. He had a big cheque coming to him for retro pay for a raise that he got. The amount was several thousand dollars and he had decided to pay off some debt (Great idea!). The question was which debt would he pay off first. He has a car loan for about $20K (5.9%), the mortgage for over $100K (6%) or a student loan at $5K (8.5%). He was concerned about paying off the student loan since he can use the interest as a tax deduction.

My personal thought was screw the tax write off and get rid of that student loan because the satisfaction of finally paying off your loan is a great emotional high which can be used to inspire you get rid of more debt. I think people tend to get so tied up in the numbers that they forget that money is a very emotional topic.

So next time you get a windfall, try to remember that some emotion in your money decisions can be a good thing.

Comments

4 Responses to “The Emotional Part of Paying Off Debt”
  1. Anonymous says:

    I’m surprised that someone with your goals would believe in wasting money like this. People do deal with emotions differently, but I couldn’t feel good about paying off a particular loan, if it wasn’t a good idea, financially. Any positive feelings from having the loan “off my plate” would be negated by bad feeling of intentionally wasting money.

  2. SeanW says:

    Greetings from another Canadian Engineer (Comp Eng, UManitoba, 1998)

    It’s been a while since I’ve had a student loan so there might be more tax credits now. But a quick calculation:

    http://spreadsheets.google.com/pub?key=pytf1zEpGwFk3AoaiF3EMEQ

    shows that with the 17% provincial tax credit the effective rate is a shade over 7% for that student loan. I used a marginal rate of 40% which is probably excessive for someone coming out of school and used simple interest & no payments to make the math easier and provide a best case scenario for the comparison.

    Besides adhering to the conventional wisdom of paying off the highest interest rate debt first, there’s also the effect on cash flow. Getting rid of that student loan frees up monthly cash that can be used for other debt or lifestyle changes. That student loan wins on both philosophies.

    I think Engineering is the best set up for personal finance. Remember that iron ring on your finger? The one that’s supposed to remind you of the cold hard facts surrounding your every day work? That’s the best methodology to use, especially for someone like you who wants to retire early.

    Sean

  3. Canadian Dream says:

    Anoy,

    I actually provided this example to show that all decisions do not have to be just numbers driven. Engineers think different than most people and can do the math. The person I based this post on was very happy about paying off the loan, so it worked for him.

    Sean – Thanks for the calculations. For the person the post was based on freeing up the cash flow of an extra $200/month was the driving factor. He now plans to take the extra cash and dump it on the mortgage.

    CD

  4. Wealthy Geek says:

    I totally agree that paying off the student loan makes the most sense. Unless by ‘several thousand dollars’, you mean enough to cover the debt on the car, but I suspect not. Paying off the student loan means dumping your highest-interest debt and frees up new cash each month, which you can then funnel onto car debt, credit card debt, mortgage, or into the establishing of an emergency fund.

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