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The debt dance: Should you pay off or hold off?

Published July 9, 2006

Say you have some spare cash. Do you pay extra on your mortgage, your home equity credit line, car loan, student loan or one of those pesky credit cards on which you're carrying a balance?

That's the kind of question I often get asked. Here's one example:

Should we deplete our cash to pay off our two credit cards (one is 6.99 percent and the other 12.74 percent) plus a second mortgage at 7.75 percent, or continue to make payments? Our debt is slightly more than our cash reserves. We are concerned that in an emergency, we would be living on credit.

And here's another:

We have a car payment and mortgage, both at 6 percent interest, and credit card debt at 3.9 and 4.9 percent. My wife and I put 6 percent each away in our 401(k)s. Do you suggest we pay down the debt, starting with the car and then the credit cards?

There is no single right way to handle debt, but there are some steps I recommend:

- First assess your situation realistically. If your debts are so large you probably can't ever repay them, talk to a bankruptcy lawyer before paying anything extra on credit cards or other unsecured loans.

- Consider taxes. If you are deducting the interest on your mortgage, home equity or student loans, figure the aftertax cost. Those probably are your cheapest loans.

- Tapping savings for debt payoff is a good idea when the interest rate on the debt is higher than the rate you're earning on savings. However, once you've done that, you need to rebuild those reserves by saving the money formerly spent on loan payments.

- If one of your loans is relatively small, aim to pay it off first. Eliminating the debt will give you a psychological boost.

- After that, tackle the loan that's costing you the most after taxes. Usually that will be a credit card, but for the reader who asked the second question, it's a car loan. He does have to be extra careful because the low rates on his credit cards could soar if a single payment on any of his cards is mailed in late.

- Rather than making payments haphazardly, develop a plan for eliminating debt (other than your mortgage and student loans) over the next five years. If you need help, consult a credit counselor. (To find one near you, call toll-free 1-800-388-2227.) Be prepared to make lifestyle sacrifices.

- Refinance debt if appropriate. Transferring a balance to a lower-rate card may be a good idea if you avoid using the card for new charges. Paying off debt with a home equity credit line may be worth considering if you can avoid new debt and you have adequate income to make the loan payments. However, it's dangerous because you're putting your home at risk.

- Remember that making at least the required minimum payment on each loan is vital to maintaining good credit.

Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, go to or write Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.

[Last modified July 9, 2006, 07:49:05]

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