Debt Management

Tips on Managing Debt Wisely

Should You Pay Your Bills First or Try to Save?

The most common advice you will see is that you should pay off your debts before you begin saving. It is highly unlikely that you can make more on your investments than the 15 – 20% you’re paying in credit card interest.

However, compound interest is a powerful tool and the sooner you start saving, the more wealth you will be able to amass. Read Get Rich Slowly to see how this works.

If you work for an employer that offers a 401 K plan that matches your contributions in part, you should make the maximum contributions and pay down the debt as fast as you can. But I would say that funding the 401 K should have a higher priority than debt reduction. (I am assuming you can afford to pay down debt and make the contributions at the same time.)

I would give the same advice if you are not funding your Roth IRA's fully. As long as you can manage your debt load, start your tax sheltered savings plan.

Of course you should still follow good financial management procedures. Cut out credit spending, so that your overall debt load is being reduced while you begin to grow your nest egg.

Mortgage Prepayment

Lots of people like to prepay their mortgages. This is all well and good and can save you thousands. However, you shouldn’t be prepaying mortgage debt if you have unsecured credit card debt.

The unsecured debt will have a higher interest rate and will take years to pay off if only minimum payments are made. Apply the extra money to the credit cards first. Work on the mortgage after they are paid.

Remember, your mortgage interest is tax-deductible.

Refinancing Your Way to Riches

It is generally a bad idea to convert unsecured credit card debt into secured mortgage debt. Even though the interest will be lower, you are stretching out your payments longer. So that sweater you bought with plastic last December might still be unpaid ten years from now.

However, if you have equity in your house, no savings and a modicum of self-discipline, consider a home refinance as a way to jumpstart your savings plan, especially if you’re now passing up your ability to contribute to a 401 K plan.

First the self-discipline: lots of people refinance their homes. They pay off their debt and all’s well for a while. They then max out the credit cards again. Now they have two mortgages, little or no equity in their home and a bumper crop of new credit card debt.

Cut up the credit cards. Call the credit card companies and close your accounts. Do not apply for new credit. Buy only what you can afford with cash.

Don’t get a Home Equity Line of Credit (HELOC) , but rather get a fixed second mortgage or refinance your first. For a second mortgage, go for a ten year term.

You should be able to get an interest rate lower than that charged by the credit card companies. Given the lower rate and the fact than many smaller debts will be rolled into one, your monthly payments will be lower. Pay off all your unsecured debts and, if possible, your car loan.

Take the money you save in monthly payments and put it first into a 401 K and next into an IRA.

If you do this right, which means that you don’t run up more credit card debt, I believe that this is a valid means of financial planning. If you don’t have the discipline, don’t do it. You’ll just make things worse.

Debt Reduction

No matter what kind of debt you have now, get a financial software package that contains a debt reduction module, such as Quicken Premier. Once you feed the proper information into the program, you will learn how to get out of debt more rapidly, simply by paying what you’re paying now.

You will also be able to play with the numbers to see how small additional payments can cut years and thousands of dollars off your debt.

Take charge of your life. Stop paying the enormous freight charged by the credit card lenders. Put your money to work for you and sit back and enjoy the ride.

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