I have $48,000 in debt. And I'm not paying it off.

Most financial planners and financial advisors recommend that you pay off your debt as quickly as possible in order to achieve Financial Independence.

I believe they are wrong. You don't need a debt repayment plan.

You need a debt management plan.

Let's make a couple of assumptions first.

Assumptions

First, we need to assume that your debt isn't a cause of any unnecessary or frivolous spending and that you won't be adding on to it. If you can't control your spending, then this isn't for you.

Second, we'll assume that the annual growth rate of your investments will be 7.5% (average yearly growth of the S&P 500 is 9.8%)

Third, your investment timeline should be 10 years or longer.

Finally, the interest rate on your loan should be less than 6.0%. This gives you a 1.5% buffer between the loan interest rate and the potential 7.5% rate of return for your investments.

Case Study

Let's review my personal financial situation.

I have a LOC of $48,000 at a rate of prime + 0.5%. Currently the bank prime rate is 3.95%, so the interest rate right now is 4.45%.

The debt that I'm currently carrying is a combination of a $20,000 RRSP contribution, a $10,000 Spousal RRSP contribution, a $6,000 TFSA contribution, a $5,000 bathroom renovation, and a $7,000 family trip to Cuba. I know, a trip to Cuba is probably not something to go in debt for. But life is for living, right?

I have available cash flow of $1,178.00 per month to contribute to my and my wife's TFSAs, to pay off my LOC, or a combination of the two.

I currently have a TFSA balance of $20,000, so I will use that as my investing baseline.

My FI date is 2034, so I will not need to pay off this line of credit for 15 years.

I wanted to see which option would leave me further ahead in 15 years, so I compared three potential options in the handy chart below.

Option 1

My first option is to just pay the monthly interest on the LOC. At 4.45%, that is $178.00 per month. I have an additional $1,000.00 that I can invest in a high growth ETF in my TFSA. After 15 years (at a rate of 7.5%), I should have a $395,000 balance in my TFSA and the $48,000 LOC still in place. Net benefit to me is $347,000.

Option 2

My second option is to put an equal amount towards the LOC and to my TFSA. If the interest rate remains at 4.45%, the LOC would be paid off after 97 months. I would then put the entire $1,178.00 into my TFSA for 83 more months. My TFSA balance after the 15 years would be $322,000. This is $25,000 less than what I would have if I did option 1.

Option 3

My last option is to pay off the LOC as quickly as possible, then put what I was paying on the loan directly into my TFSA. In this scenario, the LOC would be paid off after 45 months (if the rate stays the same), and the balance of my TFSA would be $312,000. This scenario nets me $35,000 less than my first option.

Should you do this too?

I am very comfortable doing this because I have a guaranteed consistent salary, and I know that I will always have the cash flow to cover the interest of the LOC. I am not risk-averse, and my investment timeline is relatively long term, so this works really well for me.

If you are interested in maximizing your returns, and are comfortable with a reasonable amount of risk, and you have a 10 year or longer timeline, this could work for you.

Firstly, make sure the debt that you want to carry is at the lowest possible interest rate. To do that, you could take out a secured line of credit, a second mortgage, refinance your mortgage, or even get an unsecured LOC if your credit score is low enough to get a decent interest rate.

Obviously, this would be a terrible idea if you were to carry your 8% car loan or your 19% credit card balance. Those kinds of debts need to get paid off as soon as possible.

Keep in mind that carrying a balance will reduce the amount of credit that you would qualify for if you were going to apply for a mortgage or loan in the future.

Again, this is something that I am very comfortable doing. This may not be right for everyone. If you don't know what to do, always seek professional help - ideally from a fee-only financial advisor.

Not paying off my debt gives me an additional $35,000. That's enough money to buy a boat!