Should I pay off my mortgage or pay off my credit card debt first?
Our minimum monthly mortgage payment is $1,539.64. We owe $204,020 on a mortgage with a rate of 3.8750%. Our total credit card debt is $34,000 with an average interest rate of 12%. When we have extra funds each month, should we use them towards the paying off the principal on our mortgage or towards paying off our credit cards?
You will want to pay the highest interest debt first. In this case that would be the Credit Cards. Also you get a tax deduction for your mortgage, which makes that debt even cheaper to keep.
That is a big amount of Credit Card debt, you may want to consider talking to a debt settlement attorney they may be able to negotiate a faster pay off.
Absolutely you should pay off the higher interest rate debt first. $1,000 extra principal toward the credit card saves you $10 in interest in the first month, and every motnh thereafter. $1,000 toward the mortgage only saves you $3.23 in interest each month. Plus, your mortgage interest may be an itemized deduction, meaning you won't pay as much in income tax. Your credit card debt is NOT deductible.
Would you rather avoid interest cost at a rate of 12%, or a rate under 4%? If you put $1,000 towards debt paydown would you rather save $120 per year, or $40? I'm sorry if it appears that I am going on record as saying that this is a really dumb question, but for goodness sakes!
Use every dime of your available cash to pay off your credit cards. But do more than this. Change your lifestyle. Live like a pauper for a while. Spend nothing beyond what you have to for food, shelter and basic unavoidable expenses. Rediscover the joy of home-cooked meals. Make it a game if you like -- see how much you can pay down in a given month and then try to beat that amount the next month. You didn't dig that $34,000 hole in a short time and it won't be a short time getting out from under, but do it. Otherwise you will find it increasingly hard to put enough money away for retirement.
By the way, the interest on your mortgage is only about $658 a month ($204,000 times .03875, divided by 12.). The rest of that payment is what? Principal? If so, I will assume that you have had the mortgage for many years and have built up equity in your home. If that is the case you can either (1) refinance and increase the loan amount by $34,000, thus converting a 12% debt to a 3.875% rate; or (2) take out a home equity loan (rates are not under 4%, but they're close) to pay off the credit cards.
Then, you can bank the savings from your new lifestyle into a retirement fund so you won't run out of money when you are old.
The important principle here is debt cost vs. opportunity cost, which is what the same funds can earn elsewhere (such as an investment). Even though your principal amount owed is higher on your mortgage, you are paying a higher opportunity cost by paying that down first when the same funds could be invested in a moderately allocated ETF portfolio with a historic return of 6% or greater. I would pay off the credit card debt first. If that 3.875% is not fixed, I would get that change right away (even if the rate is slightly higher) because rates are expected to rise for the next several years. It does no good to pay off the mortgage early unless you are not earning a higher return from an investment portfolio.