Four Things to Consider When Paying Off Debt
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Let’s say you have credit card balances, student loan debt, a car payment, and a mortgage. Which do you pay down first? The answer depends on your priorities. While it would be great to pay off all of your debt simultaneously, that’s not possible for most people.
Consider these pros and cons as you work to prioritize your debt:
Paying off the smallest debt first
1. Paying off your smallest debt first can give you a sense of accomplishment and may keep you on track, especially if you are trying to pay off multiple debts. If you feel overwhelmed by all of your debt, those little victories can provide you with the much-needed encouragement to remain committed to your goals.
2. Paying off the smallest debt first may not be the best plan if your priority is to pay less in interest and thereby pay off your debt as quickly as possible. For example, if the credit card with the largest balance is also the one that charges you the highest interest rate, you will be paying more interest and it will take you longer to pay off your debt.
Paying off your credit card debt before your mortgage
3. Some professionals recommend not paying off your house if you have other debt. This is because you may get a tax benefit if your mortgage interest is deductible. For example, if your marginal tax rate is 25 percent and your home loan is 6 percent, your net interest rate is 4.5 percent, or 75 percent of 6 percent. If you are paying a higher interest rate on other debt, it may make more sense to put your cash towards that more expensive debt before your mortgage.
4. If you pay off other debt and that causes you to default on your mortgage, you could risk losing your home. Would you rather take a ding on your credit report because you were unable to pay a credit card bill or lose your house? You might want to pay off your house before paying off your unsecured debt—even though you might lose the interest deduction on your taxes.
Advice is seldom one size fits all, but some professionals feel strongly that their way is the best way. The reality, though, is that each person has a different personality, different goals, and different circumstances. To decide what’s best for you, weigh the pros and cons of each option and then make a decision based on what is most important to you.
Steve Repak, CFP®, is the author of Dollars & Uncommon Sense: Basic Training for Your Money.
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