Perhaps debt management was one of your New Years’ resolutions. We actually get asked about reducing debt for children of clients, whereby clients want to help their kids better manage their debt. Oftentimes, the level of debt may not be unreasonable, just the need to understand how to manage it better. We have an expression classifying debt as good debt versus bad debt. Leverage (e.g., the use of debt) can help us with large purchases and if used well, can help us get ahead in the long run.
Examples of good debt might include a home mortgage, home equity line of credit, or student loan. Examples of bad debts are clearly credit cards. Car loans might fall somewhere in the middle, depending on the terms of the loan. One tactic we often recommend to help people who are carrying credit card balances is to see if they are eligible for a home equity line of credit (HELOC). The HELOC has many benefits as long as you don’t abuse it. It typically offers a much lower interest rate with the possibility of tax deductible interest expense. It is also useful if you do not have steady cash flows month to month, allowing you to draw down on the HELOC during negative months and pay it back during positive months.
While student loans fall under the “good debt” category for the most part, they can add up to a sizable amount and monthly payment. In addition, managing multiple student loans administered by several different loan servicers can be cumbersome. There may be advantages to loan consolidation or refinancing in order to simplify loan payments into one payment with one fixed interest rate, with possibilities of additional repayment options. However, for both loan consolidation and refinancing, there are several factors to consider, such as the type of loan (private or federal), possible benefits lost, and the viability of the company who is refinancing the loan. It is important to review the pros and cons of consolidation or refinancing to see if they are practical options for you. A good place to start might be the Federal Student Aid government website: www.studentaid.ed.gov
As far as reducing credit card debts, always aggressively pay down the high interest rate cards first and work your way down, while maintaining the minimum required payments. Another issue we see is carrying private mortgage insurance (PMI) on a home mortgage. PMI may be necessary at the time of purchase, but it is expensive, especially to carry for a long period of time. In the case of PMI, watch to refinance as soon as home equity and loan terms allow eliminating PMI. If in the end, the debt load is overwhelming, we understand the National Foundation for Credit Counseling is a legitimate place to start: www.nfcc.org
Managing debt is very much related to managing your budget, which takes us back to understanding your relationship with your money. Manage both your assets and liabilities well to help secure your financial future.
Cathie Straub, CPA, CFP®
Director, APCM Wealth Management for Individuals