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?
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.
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.
It’s generally not advisable to carry credit card debt beyond one month. If you must, then it should be your goal to get the balances paid in full ASAP. You DON’T want to be the credit card company’s best customer. Their best customer carries their balance over each month. The longer you keep the balance going, the more interest they make. I wrote about this in more detail in an article called CREDIT CARD DEBT – DON’T LET IT WRECK YOUR PLAN.
Here are some reasons to focus on the credit card debt first:
- Credit card debt is at a considerably higher interest rate than your mortgage. In general, you want to tackle debts that are at higher interest rates and work your way down.
- Credit card debt is viewed negatively by creditors. Maintaining high balances while paying the minimums will negatively impact your credit rating. Worst case is that it prevents you from getting a loan during a time of need.
- Credit card rates will increase and penalties incurred if you are late on payments. This can turn a once manageable amount of debt into something capable of derailing your financial situation.
Don’t take credit card debt lightly. Develop a plan to tackle it. Or, it will tackle you.
Please note that this should not be considered investment advice and is only educational in nature. Be sure to consult your own investment, tax, or legal professional for help with your specific situation.
Best of luck!
David N. Waldrop, CFP®
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.