Frances Cook: How Covid-19 changed the old rules of debt v investing

Rock bottom interest rates have changed the old money rules. Photo / file

OPINION:

In normal times, there's a simple money timeline that applies to most people.

When you start trying to do better with money, you pay off debt, before trying to grow wealth by investing in assets like shares.

That's because of interest rates.

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Before Covid-19 hit, debt cost more than almost any investment could earn for you.

Consider shares again. They earn about 7 per cent per year, but you lose some of that to tax, and inflation. So take it to about 5 per cent in the hand, depending on your situation.

That 7 per cent is also an average figure, flattened out across several years. One year shares might actually make you 20 per cent, another year they might go backwards, and you just don't know which will be which ahead of time.

Meanwhile, companies will be adding to the tab of your debt rain or shine every year, and the fees and interest often added up to far more than 7 per cent.

But now, post-pandemic, governments around the world are printing money and it's sloshing around in the system at cheap rates.

We suddenly see mortgages at 2.29 per cent, banks tap dancing across the bare minimum they need to charge you to keep up with inflation.

Those weighing up their money management can make a slightly different calculation now.

Credit cards and car loans are what we call "consumer debt" – and they're still an incredibly expensive way to borrow money.

You're often billed 10, 15, or 20 per cent in interest. That simply doesn't stack up – the smartest course of action is to pay it off, as fast as you can, without doing anything else that could slow down your payment plans.

But the unusually cheap rates you can get for a mortgage? That means it's worth considering your personal goals, and what you want to achieve.

On the one hand, now that the mortgage debt isn't hurting as much, there's an argument that you could get ahead by investing extra cash elsewhere.

You would be building up assets, and wealth, instead of only paying off a liability.

On the other hand, this is a time when you could pay off the mortgage faster than usual, using the cheap rates to pay extra and knock years off your mortgage.

A mortgage is a 30-year debt for many people, and interest rates will start climbing again at some point.

So if you pay off extra now, those years that you knock off the payment plan could save you from making payments at higher interest rates in the future.

What about student loans? We're lucky to have interest-free student loans here in New Zealand, which means technically, your student debt gets smaller over time.

Inflation means money is worth less every day. Just think about how much bigger a dollar mixture of lollies from the dairy used to be when you were a kid, compared to what you can get now.

So while you never want to miss a minimum payment, there's an argument for simply letting the student loan tick over, while investing your cash elsewhere to let it grow.

Of course, some like to know they've got that debt monkey off their back, and that's valid too.

As always, it comes down to a combination of your life goals, personality, and which way the monetary system is tilting.

But the new rock bottom interest rates certainly have changed the way many will be weighing up that calculation.

This column is general information only, not individual financial advice

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