PAY OFF YOUR DEBT THE SMART WAY
2. Pay Off Your Debt the Smart Way
More often than not, the smartest financial move you can make is to take any savings you have (above and beyond money you need for essentials like rent, food, and health insurance) and pay off your high-rate loans. The reason is simple: You can “earn” more by paying off a loan than you can by saving and investing. Paying off a credit card that has a 16% interest rate is equivalent to earning 16% on an investment, guaranteed—an extremely attractive rate of return. (Actually it’s even better than that; it’s the equivalent of earning 16% after taxes.) If you want a full explanation of this concept, turn to p. 34. Otherwise, take my word for it.
If you can’t pay off your high-rate debt immediately, take steps to reduce the interest rate you pay. Start by simply calling your credit card company and asking them to lower the rate. Also, see if you can qualify for one of the lower-rate cards listed on websites like www.credit.com, www.cardtrak.com, and www.lowcards.com.
If you have several different types of debt—say, a credit card balance on a card with a 14% interest rate, a car loan with an 8% rate, and a student loan at 5%—pay off the loan with the highest interest rate first. One strategy you may want to consider is asking your student loan servicer to stretch out your student loan payments over 15, 20, or even 30 years instead of 10 years. This will reduce your monthly student loan payment and leave you with extra cash, which you can use to pay off your credit card balance faster. Once you’ve gotten rid of your credit card debt, increase the payments on your auto loan. After you wipe out that loan too, increase your student loan payments to at least their initial levels.
The only time it doesn’t make sense to kill your debt is when the interest rate you’re being charged is lower than the rate you can receive on an investment. If, for example, you have a special student loan with a 3% rate and no other debt, you’d be better off maintaining your usual payment schedule on the loan and putting your cash into an investment that pays you an after-tax rate greater than 3%, if you can find it.
Crib Note #3: Start contributing to a tax-favored retirement savings plan