Sunday, March 1, 2009

Re-negotiate debt for long-term gain

More than anything else I do, I love to answer questions from folks I meet in person and online. This is a question from a reader, and we'd love to start doing this more. If you have a question, leave it in the comments section and I’ll post response here. Keep the questions coming!

Question from a reader:
I have a loan against my minivan for about $9,000. I also have a home mortgage and a second mortgage. The car loan is at 9 percent, and the second mortgage is at about 7 percent. We do not have any credit card debt. We save for our kids’ college funds and for our own retirement at modest but not aggressive rates.
I am self-employed, and my husband works for a non-profit. Both of us feel secure in our employment and income, but we also are aware that many, many people who thought they were secure are now unemployed. We want to take our extra income and pay off debt as well as save. In what order should we proceed with the following three objectives:
1. Create a savings fund of three to six months of expenses.
2. Pay off our minivan.
3. Pay off the second mortgage.

Answer from Dan Danford
Actually, this is an interesting family finance query. In the scheme of things, none of this debt is "really bad" debt. It's pretty hard to live today without borrowing for houses and cars, so the pertinent question for most people is how to arrange the best terms and conditions. Generally, you'd eliminate the highest-cost debts first, so pay off the car loan. I'm not keen on paying off mortgage debt for multiple reasons, but especially not if you sacrifice retirement savings to do so (the Chicago Federal Reserve Bank released a study on this very subject last year). My first question for your situation is this: can you refinance your mortgage(s) at today's low rates? If you can, it's possible that you could combine all three of these loans into a single mortgage at 5 percent or less.
Some might find this an odd recommendation from a financial advisor, but your income stability and lack of (really bad) credit card debt makes it feasible. And, if you can secure a loan at 5 percent or less, why be in a hurry to pay it off? Your retirement or college savings will likely grow at higher rates for the entire mortgage term, so why move money from higher rates to pay off lower ones? Really, having good income and credit creates the flexibility to secure good terms and conditions. Use it to good benefit for your family.

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