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Savings & Spending Tips Debt Management Debt management is critical to financial success. If used wisely, debt can help you create wealth. A good example of this is a home mortgage, school loans and small-business loans. If used unwisely, debt can keep you from reaching even the most modest financial goals with credit card debt being the greatest danger. Advantages of having debt: Provides ability to trade future income for current enjoyment Convenient Can "free up" money that might be better invested elsewhere Disadvantages of having debt: Ties up future income Can lead to overspending Increases total cost of goods Debt Management Tips Consider all possible sources of credit Shop for the lowest rates and the best terms Do not borrow more than can be repaid on time, considering both present and future income If borrowing for investment: After-tax return must exceed after-tax cost of borrowing The return is subject to risk, but debt must be repaid If you find your debt is getting too large, move quickly to resolve problems Don't borrow for an asset that depreciates Analyze your personal debt. Complete the Financial Overview Quick Report now. Debt management — mortgages Take the time to shop for loan rates for any major purchase, but especially to purchase a home. Be sure to check into any mortgage programs you may qualify for (e.g. first-time homebuyer programs, etc.). Question: Is it better to pay down a mortgage or to invest those extra funds instead? Answer: It depends! Here are some factors to consider: What is your tax bracket? (See the Marginal Tax Bracket Table in the Reducing Taxes section.) That 7% mortgage rate may only be costing you 4.6% after taxes. How long might the money be invested? A long-term return of 7%-8% on a diversified portfolio is better than paying off a 6.5% mortgage. Question: Should I refinance? Answer: Again, it depends! Are you lowering your monthly payment, even after factoring in the costs of refinancing? Will you be able to pay off the debt sooner? Are you freeing up money to pay off other debts? How long do you plan to own the property? (The longer you plan to own, the more sense it makes to refinance.) Will the cost of the loan overall be lower? Make sure that you either work through these analyses yourself or seek the advice of your financial advisor. Should you refinance? When interest rates go down, as they have recently, it becomes very popular to refinance the mortgage. By refinancing, you can free up additional monthly income that you can better use by investing for your retirement or paying off other debts. However, it does not always make sense to refinance. If you are already seven to eight more years into your 30-year mortgage, you've already paid a lot of interest. So make sure the new rate is low enough that your overall interest cost will be lower. Even though you may reduce your monthly payment, it may make more sense to refinance with a 15-year mortgage, rather than incurring additional interest. Also, don't forget to factor in the fees and any points you may have to pay. In other words, don't assume that just because interest rates have gone down, it's in your best financial interest to refinance. Research! Debt management — credit cards Use credit cards wisely. Consolidate debt Pay balances monthly Never borrow for luxuries if you are having trouble affording necessities Reserve some borrowing power for emergencies Credit cards can be a convenient way to manage some of your financial affairs, but too much of a good thing can encourage bad spending habits.   Quick Question What is the average credit card balance per American household in 2001? A. $10,800 B. $5,500 C. $8,300 D. $3,800 Let's assume that you charge a $500 refrigerator on your credit card and you pay down that bill by $15 each month. That $500 appliance will actually cost you almost $700. Credit cards can be a useful tool or Public Enemy Number One. Use them with caution. Tips for reducing credit card debt Destroy your card or freeze it in a bowl of water. By the time you've picked your way through all that ice, you may have second thoughts and decide to put it back into the freezer! Pay more than the minimum payment. Focus on paying off the card balance with the highest interest rate first. Double up on payments if you can. When that balance is paid off, put all of that payment on the second card. Take advantage of the teaser rates you get in the mail, and transfer debt on the cards with high interest rates to cards with lower interest rates, if possible. Credit card companies frequently offer special low rates through the mail if you sign up for their cards. These lower rates may by available only for a period of time, such as six months, but if you can consolidate balances from cards with higher rates into this card with a special rate and pay off the debt during that special rate period, it would be a strategy worth considering. Transfer your debt to a home equity loan. You'll probably be borrowing at a lower rate of interest and it may even be tax deductible. Use savings to pay off cards. Why earn 3% on savings while paying 16% on debt? If you pay off that 16% card instead you just made a risk-free 16% return! If the above strategies still aren't enough, you may want to consider additional income that may be generated from full- or part-time work by a family member not presently employed. Extensive debt is the leading cause of financial failure. < PREVIOUS NEXT > #38599