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Woman managing debt repayment with help from Myrick CPA DC
Posted by: Charles P Myrick CPA Posted on: Jan 04 2022 Posted in: personal finance, debt management, saving and budgeting

Loans: Pay Off,  Consolidate, or Refinance?

The current US personal debt, including mortgages, has reached $14 trillion, with a total annual income of $19.68 trillion. That works out to a median household yearly income of $79,900 with total debt of $145,000. So is there a magic formula for paying off debt? The answer is yes, but how each household approaches this will vary, depending on the details of their interest rates, duration of loans, income, other expenses, opportunities for relief, credit available, and level of debt.

Refinancing and Consolidation Options

Refinancing involves asking your original lender or a competitor for a new, lower interest loan to pay off your existing loan. Refinancing in this way reduces your interest rate, so it costs less to pay back in the long run. Consolidation loans or services combine multiple debts owed into one payment. These can be good, but make sure the interest rates make sense, lowering the total you pay off without drawing it out much longer. An additional benefit of both types of loans or services can be that you get a month or two of halted payments as the process moves forward. This gives a well-needed breather to some families and helps them catch up with other bills, including rent or mortgage payments. If your new refinance includes your mortgage, all the better. 

Loan Scams to Avoid

Don’t fall prey to lenders who take advantage of your hard times for a quick buck. Avoid paycheck or car title loans or any high-interest rate or stipulation to make weekly or daily repayments via direct debit. In most cases, you’ll pay exorbitant fees, which ultimately leave you worse off than before the loan. 

When To Pay Off Your Loans

It feels great to pay off any type of loan. You breathe easier getting out from under debt, right? Along with lowering your debt, you could save money on interest while improving your credit score if you pay off loans before they mature. Conversely, make sure not to hurt yourself with penalties or fees for early pay-offs. If you pay off any loans, get rid of the high-interest debt that you could not refinance first. 

Paying Off Debt and Loans vs. Saving and Investing

We usually recommend paying off debt before investing since your debt interest rates could cancel any positive interest or other financial gains. However, take a careful look at the interest rates on each option before you decide. For example, suppose your current interest rate (for repayment) is below 5%. In that case, you might do well to put a portion of your budget into retirement or emergency savings while you also tackle debt repayment.

Since student loans don’t charge interest while deferred, now may be the time to invest before making student loan payments. The same goes for any other debt with interest lower than 5%, including credit cards, medical debt, and car loans. Limit current payments on low-interest debt to contractual minimums, but don’t overpay or pay off. Most investments will give a return higher than 5%, so focus on investing or saving when you find such high returns. On the other hand, don’t starve your investments if you have low-interest loans that gain you little from an early payoff.

While the conventional wisdom for managing personal finances generally still holds, Myrick CPA understands that today’s recovering economic environment is complex with many moving parts. Confused about what direction to go when planning your debt repayment? Contact us today to schedule your free consultation.