Should I pay off my debt with money from my savings or by refinancing my house?
I have two auto loans and some credit card debt that totals to about $29,000. I have $38,000 in my savings so I was curious if I should pay off my debt with that, which would leave me with a $9,000 nest egg.
Alternatively, should I refinance my house to pay off that debt? I bought my home in 2010 for $128,000 and currently owe $104,000. My house is approximately valued at $225,000 which leaves me a bit of equity. What would be the best choice?
I'm sure you're getting different answers on this. It really is a matter of personal preference. But here's my thinking...if you refinance your house, you're not really getting out of debt. You're just moving the debt from one pile to another. Your total monthly payments may drop some, but you'll still owe the same amount of money. Plus, you'll increase your mortgage payment for the next 15 to 30 years. If you total the difference in your mortgage payment, you may not save any money with the refi.
The down side of paying off the debt out of savings is you'll have less savings. But you'll also have more money every month due to the debt payoffs. If you commit to putting the money that would go toward debt payments back into savings every month, my guess is you'll rebuild your savings in no time at all. And you won't have increased the idebtedness (or risk) on your house in the process.
Between those two items you have a net worth of $9,000 any way you slice it. The way you have it now, you are paying a lot of interest on $29,000 and earning very little on $38,000. The interest is a drag on your income.
You should pay off your debt and not incur any more. Your goal should be to reitre debt free. You don't say how far away retirement is for you, but it really doesn't matter. As long as you live within your means, it will be better to have $9,000 in savings and not $38,000 with a lot of high cost debt. However, a lot depends on how secure your job is. Do you expect to get promotions and raises? If so, keep your lifestyle modest and "pay yourself" by adding to your savings every month at the same time as you sit down to pay your other bills. Invest prudently and for the long term. Your goal is to have 20 times your living needs in liquid savings by the time you retire. (It might also be nice if you had no mortgage. So don't increase the debt on your house now.)
You have not stated the interest rate on your auto loan, so I can only provide some general guidance. I think it is safe to assume the credit card debt has a high interest rate associated with it.
For the credit card debt, the rate is likely to at least be more than 10% (after all, the average for new cards is 16-17% currently). Assuming that's correct, I would do all I could to pay that debt off as soon as possible. I would prefer to use the cash to pay it though. If you use a home equity line of credit to pay it off, then you're essentially converting what should be short-term credit card debt into long-term debt. That's not usually a good trade.
For the auto loan, if the rate is relatively low (say 4%-5%), you could consider just paying it off on a normal schedule. That decision would be impacted by what else you might be able to do with the money. If you are above 4%-5%, you might also see if you can find a better rate on that debt after you repay the credit card debt.
Regardless of whether you pay off the debt using home equity or your cash, your net worth will remain the same (equity in your home + $38,000 cash - $29,000 debt = equity in home + $9,000 cash) vs. equity in your home + $38,000 cash - $29,000 home equity loan = equity in home + $9,000 cash (net)).
If the interest rate on your auto loan is relatively low, you should also consider using at least some the balance that is not used to pay off your credit cards to start an emergency fund. Such fund typically has enough in it to fund 3-6 months of your expenses.
Overall, my recommendation would be to try and live within your means once you pay off your credit card debt. The high-interest rate you pay on credit cards is very costly. It can make simple purchases ultimately cost a lot more than you assumed at the time the purchase was made.
I hope this helps. Feel free to reach out if you have further questions.
Rolling short term debt into long term debt is never a good idea. That would effectively mean paying off those credit cards for the next thirty years and what you actually bought with that money may already be a dim memory. You don't mention your income or living expenses, but your emergency savings should be equal to about six months of living expenses. If the $38,000 is more than that, then I would use the excess to reduce the portion of debt that is credit card debt. You don't say what the breakdown is between auto loans and credit cards.
If there is no excess from the $38,000 emergency fund, then you might transfer the credit card debt to a promotional 0% card and aggressively pay off the principal during the promotional period. With the credit card debt eliminated, you might qualify for better interest rates on the auto loans. If you are already below 4% then that is no more than the mortgage rate you would have gotten, so continue to make payments as planned until they are paid off. If you are above 4%, shop for promotions from banks or credit unions, including online lenders.
Not knowing the break down of the loan amounts I will make a couple of generalized comments. Getting out of debt is something everyone strives to get to but this should not be accomplished at the expense of our saving for emergencies or other goals. If we walk away from those goals we will most likely put ourselves back in debt. If the payments are difficult to deal with then paying them down makes sense. I would start with the credit card debt as the interest rate on it is usually much higher than that of an automobile. If you still need to lower payments on your auto debt consider looking at refinancing them. Even though interest rates have increased over the last couple of years credit unions often still offer attractive terms for refinancing. If you applied all these loans to your house you will pay new closing costs that will require either part of your savings or an increase in the interest rate and therefore payment you are making. This payment may be cheaper than just refinancing the car but you will own that debt for 30 years and the car will most likely be in the junkyard by then.