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Improve Cash Flow by Paying Off Long-Term Debts

Written by Laura Martinez - 43 Comments

Improve Cash Flow by Paying Off Long-Term DebtsIncreasing your monthly your cash flow can be financially empowering. So many people are burdened by high interest credit card debts that represent a big chunk of their monthly expenses. Credit cards, though, aren’t the only debts you need to eliminate from your budget to increase your cash flow.

Normal debts and cash flow

Have you’ve thought of focusing on and paying off ‘normal’ debts, like car loans, student loans, and even your mortgage? Have you considered the effect of doing this on your cash flow, not only on a monthly basis, but in long term?

This is not a new concept; Dave Ramsey has talked about this in his financial programs for years. If you review the 7 baby steps, you’ll see that he talks about removing car loans, student loans, and even mortgages payments from your budget.

We have two debts left, my student loans and our mortgage, and we’re really trying to figure out a long-term plan. These are both relatively low interest debts, and we can comfortably cover the payments. Although many people would be comfortable just making payments, we’re looking at what would work best for us both financially and personally.

Paying off your car loan

Out of the three types of longer-term debt mentioned above (car, student, and mortgage loans), I really think you need to get intense and cut expenses to pay off your car loan ASAP. Car payments are not only a drain in themselves, but many lenders have specific insurance requirements that can add to the total costs.

Our car payment was something that we knew we wanted to eliminate sooner rather than later. We started by cutting back on bills that weren’t important to us like cable TV and a landline phone service. We also allocated money from blogging and tax refunds to help pay down the car loan. Sending in the extra money help motivate us further because we were seeing the balance get smaller and smaller.

We also got aggressive with our car insurance, searched for a better deal, and managed to cut our car insurance premiums in half. My advice when shopping around is to have a copy of your current policy in hand so you can make direct comparisons. It’s hard to keep up with all the details without having a reference point.

With the car payment gone, we now have an extra $235 each month available. The great thing is that once you’ve paid off the loan, you have options. I would put at least some of your monthly car payments into a car replacement fund. Cars eventually break down, so being prepared is the way to go. We opened a subaccount at ING Direct to keep the money secure and earn some interest.

Student loans: low interest, but still debt

Some people want to pay their student loans off on schedule, using the full ten years. I can understand this viewpoint because the interest rates for federal student loans can be quite low. Private loans, however, can be expensive and thus worth eliminating as quickly as possible.

Though I’m consolidating my student loans and while the interest rate is very low, I’m still going to attack my debt ahead of schedule. After setting aside money for retirement, any extra money I receive from my online endeavors will go towards paying off my student loans. I admit that we’re not as aggressive with this loan as we were with the car loan, but we’re still paying extra.

My advice for those looking at paying this off in an intense manner is to have a support system in place. Since student loans are usually pretty large, having that support system can help you stay focused. Find a friend or family member to hold accountable and keep you focused. Paying this loan off would give us $200/month to reallocate, most likely to paying down the mortgage and increase our charitable giving.

Eliminating the mortgage – run your numbers

Paying off the mortgage early has many supporters and detractors. Many people will argue, and with some good reasons, that it’s better to invest your money than pay off your mortgage. I’m arguing today from a cash flow perspective. Having a mortgage is our biggest single expense, and if we paid that off sooner, then we could save tens of thousands in interest payments.

We don’t, however, want to do this by sacrificing our retirement goals. That’s why we are continuing to invest for retirement while paying down our mortgage. I don’t think these goals have to be mutually exclusive, you have to figure out how you want to allocate your money yourself.

Our goal was to create a realistic plan that we can keep and would not be a huge blip in our budget. The plan? We’re taking the first-time home buyer’s tax credit and using it to pay down our mortgage. In addition to using our tax refund for the same purpose, we’ve also automated an additional $150 every month to go towards our mortgage principal.

Running the numbers, we found out that this small adjustment (without factoring in the tax refund) will cut ten years off our mortgage and save us $42,408.57 in interest payments! We will have 10 years to spend over $600/month as we see fit. This is definitely something that we want to accomplish. For us, having a paid off mortgage gives us both increased cash flow and some peace of mind.

Your thoughts

Have you been accelerating your debt repayments? If so, how do you decide which loans to pay off faster? Are you accelerating your car loan, student loan, or mortgage payments? Why or why not?

Published on March 23rd, 2010
Modified on September 27th, 2013 - 43 Comments
Filed under: Debt Reduction

About the author: helps families achieve financial freedom by sharing tips for reducing debt and building freelance income over at Couple Money.

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43 Responses to “Improve Cash Flow by Paying Off Long-Term Debts”

  1. 1
    savvy Says:

    We’ve been accelerating our debt repayments. We targeting the car loan first because that will free up cash flow (even though it has the lowest interest rate). Next, we’ll snowball my student loan (the highest interest rate) and then the mortgage.

  2. 2
    Joshua Says:

    My student loan interest rate is .625% When I make a $120 payment towards it there is like 3 dollars of interest. It’s not necessary when the interest is that low to speed up payments, but I guess you could say I’m paying over the minimum so I am essentially speeding it up anyway.

  3. 3
    AJ Says:

    My car note is due to be paid off in September 2012; I’m paying it off (lord willing) this year :D . That will free up $350/month.

    Would you be surprised to know that student loans are actually our biggest expense? Between me and my fiancee, student loans are $2800/month; our rent is $1730. Interest rates on the federal loans are quite low, which make up the bulk of the loans (almost $500k total). But I have almost $90k remaining of private loans, and while the interest rate now is quite low–my highest is only 3.3%–I have every reason to believe that those rates will increase in the future. Therefore, I’m paying off the car note now, and after our wedding will be funneling extra money into the private loans while the rates are still low.

    He’ll be going into a medical residency next year and will be able to defer his loans, which are all federal. We’ve decided to try, during those five years, to pay off all of my student loans, so that when he finishes we’ll only have his to worry about, and $200k less in debt in our names.

  4. 4
    Bryan Says:

    Hopefully, most of us have learned that our house is not an ATM, where we can pull money out to spend on things we can not otherwise afford.
    Now we have to grasp the concept that “our house is not a piggy bank”, a place to store our extra money. Accelerating the mortgage payoff by making extra payments is not a prudent strategy. By saving or investing the extra payment amount instead of immediately applying it to pricipal, then paying the mortgage off when you’ve accumulated enough in that account, you will accomplish the same results with much less risk and much more control.

  5. 5
    Jackie Says:

    I am paying off my car loan this year!
    For first time in my life (I am 44 y/o) i took out a 12K car loan a year ago. I should have bought a used car cash for 7K or so.
    I will never take out a car loan again in my life. Vehicles depreciate so quickly that in two years or so it will most likely be worth about 8K. What’s the point?
    I would still be paying it off for another 5 years at a cost and interest rate that’s much higher than what the car is worth. So i am paying it off much quicker.

    Lord help me but i am never taking out a loan again for a vehicle. I’d much rather get a cheaper one with more mileage.

  6. 6
    Lifting the Blinders Off American Eyes Says:

    Spoken like a true “lender”. I am sorry Bryan but i couldn’t disagree with you more. Everyone I know that was in the stock market (investments) has had their account dwindle so low that they have to work another 10+ years beyond retirement AND still deal with ridiculous mortgage payments.
    The strategy of paying into your “diversified and conservative” retirement while paying down your mortgage at a faster rate is not only sound but financially prudent. For many, the money you save on interest is substancially greater that what one will make in investments. There are Americans floating around with adjustable rate mortgages whose interest fluctuate between 7 and 18%.
    How many investments do you know of in the last 5 years that are paying around a steady 12+%?
    You’re lucky if you hit 8% off an on.
    There are many others whose credit is so pitiful due to job losses or other circumstance that their “fixed” mortgage interest rate is at a “fixed” 7% or higher.
    How many stocks do you know of that provide a consistently “fixed” 8% + return?
    In this economy stocks tend to fluctuate in a downward spiral more so than going up.
    Most of the people i know that “recommend” not paying a mortgage off early are lenders. Lenders still fighting hard to keep blinders on Americans.

    >>>Accelerating the mortgage payoff by making extra payments is not a prudent strategy. By saving or investing the extra payment amount instead of immediately applying it to pricipal, then paying the mortgage off when you’ve accumulated enough in that account, you will accomplish the same results with much less risk and much more control.<<<

  7. 7
    Laura Says:

    @savvy, Joshua , AJ, and Jackie: Glad you guys have a plan on getting some debt paid off! Hopefully having a better monthly cash flow can improve your options for other financial goals.

    @Bryan: Thanks for sharing your thoughts. I think paying off your mortgage while investing is a way to be financially responsible. It certainly isn’t the only way, just the way that works for us. Our house is not an investment or a piggy bank, it’s our residence.

    From a cash flow standpoint, not having a mortgage greatly reduces our monthly expenses, which can be redirected into other investments instead of paying so much in interest to lenders.

    @Lifting: Thanks for pointing out you can do both – pay down the mortgage and invest. They are not mutually exclusive. :)

  8. 8
    AJ Says:

    @6: I didn’t read that “lender” perspective at all from what Bryan said. What I read was put that it makes more sense to save the money–he wrote SAVE or invest–than apply it to principal immediately. If an emergency comes up that requires the use of those funds over and above your EF, they’re available. If not, you can use them to pay a huge chunk off of the principal, or pay the mortgage in full if you desire to wait that long.

    The fact is, paying more toward the principal on a fixed-rate loan won’t change your payment amount. The difference is that those funds may not be available when you need it.

    I don’t own a home, and when I do, I hope to pay it off in 15 years on a 30-year mortgage, but I understand what Bryan is saying and think that it makes sense, depending on your personal situation. And saving vs. investing is dependent on your risk tolerance. I personally wouldn’t invest it, but I’m fairly conservative that way.

  9. 9
    Evolution Of Wealth Says:

    It’s a target market problem. For people that are responsible, working hard at or have already paid off other debts; you might call them more advanced financially. Using a side account rather than throwing extra money to the bank can work great. I’m not a fan of investing this side account or using a retirement account on the side because of risks, liquidity and other things mentioned.
    For the average debt ridden person this isn’t a good strategy. Of course they shouldn’t have extra money to put to their house when it probably should go to high interest credit cards.
    However, if you cash flow warrants it, people should way the option of saving on the side versus paying down the mortgage. It will work differently depending on your situation. Just keep an open mind.

  10. 10
    Nickel Says:

    Speaking from experience… We paid off our mortgage early, and I haven’t had a single regret.

  11. 11
    wrc1000 Says:

    We round up the monthly payment to the next hundred dollars ($1200 in our case) and also make $500 payments to principal every 2 weeks on paydays. Also any “extra” or “found” monies go to principal only payments also. With this schedule, we will pay the mortgage off 4 years from now, which would be about 6 years early on our 15 year mortgage (fixed at 5.375%). The mortgage is our only debt left.

  12. 12
    Matt Jabs Says:

    Ha ha, I love a good “Pay off debt to free up cashflow” article!

    If you remember, just last week I polled the financially savvy FCN readership about repaying the 2nd mortgage or student loan first. We just paid off all non-mortgage and non-student loan debt and have moved into the next phase. The response was overwhelmingly keen on repaying the 2nd mortgage first, then a couple readers had the idea to save my extra monthly cash flow to increase security and monetary control. I liked that idea a lot!

    We decided to pay some extra toward the principal and save the rest for lump sum debt payments. This will give us the best of both worlds. Extra cash for security in a poor Michigan job/housing market, and increased debt reduction.

  13. 13
    Petunia Says:

    Personally, I think the balanced approach is the way to go; save AND invest AND prepay your mortgage.

    @Lifting the Blinders: Your statements seem to indicate you are confusing long-term market returns (the long-term return of the US market continues to be 11+%) with short-term market returns. If I am a long-term investor, then what the market did last year, or even the last 5 years, is irrelevant to me.

    Also, since interest rates on mortgages have been very low for many years now, I find it difficult to imagine that there are many people paying 7 – 18% on their mortgages.

  14. 14
    Jessie Says:

    Until very recently, our only debt was student loans and a mortgage. We’ve been paying extra on both. Our student loan debt has very low, fixed interest rates, so I know it doesn’t make much financial sense to pay them down early. However, when we graduated college a few years ago, the student loan company put us on 20 year repayment plans. The thought of having that debt for 20 years was suffocating to me. By paying a little extra each month, we will pay them off in almost half the time. While it may not make much sense financially, mentally, it was an absolute necessity for me. Similarly, some could argue I’d be better off saving the extra money I’ve been putting toward my mortgage every month. Maybe they’re right. To me, that’s money I owe, and I desperately want to one day not owe anything. Also, as mentioned, the cash flow. Without a mortgage payment, we would have so many options in terms of work (switching to one income, doing just contract work, etc). I very recently took out an auto loan, and will probably stop extra mortgage payments temporarily and focus instead on the auto loan for reason that are probably obvious.

  15. 15
    Jennifer Lissette Says:

    The year of 2009 was a big debt busting year in my household. We replaced one of our vehicles but we paid cash for a used car rather than take a loan for a new car. We also made early payments on my student loans and eliminated the $15k I owed. This year we are hard to pay off our second mortgage, a sum of about $70k. According to our projections, we should have it paid off by this time next year. After that, we plan on tackling the first mortgage, but we’ll probably try to budget in a little vacation first.

  16. 16
    Bryan Says:

    @Lifting: I’m not advocating investing in stocks vs. paying down the mortgage. I am also not suggesting to not pay the mortgage off early. I tend to ramble so I tried to keep my point short and sweet :) . Sorry the point did not come across right.
    What I was trying to say is there are two ways to pay off your mortgage early, the first is through additional monthly principal payments, the second is to save that amount each month (in a savings account, in a pillow case, etc.). The stock market is obviously NOT the place to do this.
    I consider the first method less prudent mainly because the second method keeps you in control of your money, has immediate tangible results, and leaves your money liquid.
    Liquidity is a significant problem for way too many homeowners today. I have personally seen people who made extra payments to their mortgage each month for years lose everything because they fell on hard times and had no liquid funds to cover themselves through a crisis. If that money was in their savings account instead of in their homes equity, they would have been in a much better position. Yes, their mortgage payoff plan might have been postponed, but they would have a better chance of not losing everything, or at least have enough time to figure out the best way to move forward without panic.
    If it will take 20 years to pay off a 30 year mortgage by paying an additional $150 per month toward principal, it will take 20 years of saving $150 a month to be able to pay off the mortgage at the same time , and still save ten years worth of interest. Either way, the “saved” interest is realized after the mortgage is paid in full.

  17. 17
    John Says:

    I am planning to open a Reward checking account in a couple months for the purpose of saving up extra money to use for debt payoff, etc. After a couple things that will be paid off in May, my highest interest cost is 4.25% for the next year.

    Keeping liquid savings is important for me because my vehicle is 8 years old along with a few other possible needs for money in the near future. If I put every dime I make against my debts, I don’t save any interest in the short term due to my favorable loan rates. If I keep the cash around and make 4% interest on it, then if I need to make a large purchase I can use cash to negotiate a better deal.

    If everything works as planned then I will not need the cash and I can pay off my debts and move on. Even if my debt cost was a little higher than the interest I could make in the Reward checking, it would be a small cost to pay to have the flexibility of liquid savings.

  18. 18
    Tyler Says:

    I must be in the minority – my wife and I have two car loans and her student loans, with the student loans being the highest interest rate (6.8% vs. 5% for each car loan).

    Given the student loans are also the highest principal (and therefore the highest payment), it’s a lose/lose – paying off a smaller loan to get the higher cash flow means keeping the highest interest loan at a larger principal than necessary.

  19. 19
    Petunia Says:

    @John: Where is that reward checking? I would like some of that 4% action.

  20. 20
    Michael Levine Says:

    You stated it very nicely:
    1. Don’t sacrifice long-term retirement goals
    2. Be aggressive in paying off high interest rate debt first
    Unless I missed it in your blog, I would suggest that you build an emergency cash fund before making prepayments on your debt.

  21. 21
    Bibledebt Says:

    You really need to be gazelle intense and have a long term vision. If you can’t see past the end of next week and you are just feeling your way a long, you will be in the same position next week, next month and next year.

  22. 22
    Nancy Says:

    Wow..this thread is so timely for me! I just made a large payment to a personal loan that will free me up 430.00 a month.

    My cc total is over 55k…even though my personal loan was at a lower rate, this was a very hard decision, now I feel FREE!!!

  23. 23
    Rosa Says:

    Congratulations, Nancy! Now you have some “give” in your budget and some more money to throw at that $55K.

    I paid off my student loan about 8 years ago now, and we’ve never had a car loan. We actually just temporarily stopped overpaying our mortgage because our escrow & total required payment went up. The plan is to go back to overpaying in the fall when our son starts school & we don’t have daycare expenses. But we overpaid the first 7 and a half years we had the mortgage, so we’re pretty far along anyway – only 9 years left at this point. Not overpaying is going to put us a little past our 15 year payoff goal.

  24. 24
    John Says:

    @ 19 Petunia:
    http://www.bankrate.com/financ.....study.aspx

    There was a recent article on Bankrate talking about reward checking. There are a few in there that require only 10 debit transactions a month and make 4% interest. This is not something you can just toss some money in and watch it grow. It needs to be an active part of your daily money workings to make it worth your while.

    I have used the same checking account since I was 15. I think it’s time to get something that offers a bit more.

  25. 25
    Harrken Says:

    I recently paid off everything using a Dave Ramsey type Debt Snowball. The last thing I paid off was my car loan and by that time I was paying over $1500 a month on it. I paid off my entire loan in less than a year.

  26. 26
    The Rat Says:

    In my view, eliminating that mortgage is probably the best thing anybody can do in order to free up a boatload of cash flow. Once that’s done, you can park your hard-earned dollars in investments.

    Nice post.

  27. 27
    Megan Says:

    We have no consumer debt & no mortgage, just one personal loan at a low interest rate (thanks to USAA) and lots of student loans. Overall we pay $800/month in loan payments which with only one paycheck is a significant chunk of our cash that I would rather save or invest. We have decided to put an extra $500/month towards our loans and another $400 towards our Roth each month. This will have all of our loans paid off by the end of next year. It will be such a weight off our shoulders. They have low interest rates but to us we would rather feel like we have complete control over every penny and have it working for us rather then paying off loans for the next 20 years.

  28. 28
    Charles Cohn Says:

    You said that when you get your debts down to a certain level you can resume giving to charity. Why? Remember that if you refuse to pay your taxes, ypu will go to jail, but if you refuse to give to charity, nothing will happen to you. If you have any debts at all, you can’t afford to give to charity.

  29. 29
    John Says:

    “If you have any debts at all, you can’t afford to give to charity.”

    I can’t quite agree with you there. Charitable giving should still be allowed when you owe money and there are several reasons for it. It should be kept reasonable, however.

    reason 1: Need has no season. If my financial situation allows me to borrow money for low interest, then I am in much better shape to give than the needy ones are to borrow. My financial strength and borrowing power is part of what I can give, even if I have debt. If you are paying 20-30% interest on CCs, I would not recommend any substantial charitable giving.

    reason 2: tax deductions. Just because I still owe on my house doesn’t mean I don’t owe taxes, and charitable giving is a great way to reduce your tax burden if you already are putting away plenty for retirement in a tax-deferred savings vehicle. Think of charity as investing in your world and it makes more sense.

  30. 30
    Matt Says:

    Two points:

    1) Using leverage on a depreciable asset like a car never makes sense from a financial perspective. Pay off your car loans ASAP. Leverage magnifies both returns and losses. You’re sure to lose on a depreciable asset, and leverage just makes the loss worse.

    2) I’m surprised no one has brought up taxability of interest payments. This is another reason it makes sense to pay of your auto loans before student and/or mortgages.

    Currently my student loans carry a 2.8% interest rate. That means that my effective after-tax interest cost is 2.10% on those loans. Why would I sacrifice saving for retirement to pay those off early? I’m effectively borrowing for next to nothing to save for retirement, because over the long term I think I can do better than 2.10%. Same goes for my mortgage. My effective interest is 3.75%. Same story. Obviously this assumes you’re not under water on your mortgage or have other liquidity problems.

  31. 31
    Matt Says:

    Also, on 4% high yield checking…there’s no way any bank can afford to pay that for very long. That has to be a short term teaser rate. The 10 year treasury is only at 3.89 right now!!

  32. 32
    AJ Says:

    @Matt, #30:

    Not everyone is as fortunate to have low student loan rates, particularly if you have private loans. My loans are all low interest now, but it makes significantly more sense for me to attempt to pay off my private loans NOW while the rates are low, rather than funnel spare cash into retirement while the interest rates rise on the variable private loans. BTW, I have no workplace retirement plan, and I max out my Roth IRA at the time, so for me I’m talking about outside investment vehicles. I’m also well past the income limit to deduct student loan interest, even though I pay close to $10k in interest per year.

    Paying off loans is intensely personal and therefore, even if there may be a mathematically “correct” answer, it doesn’t necessarily make it a right answer for everybody. If my fiancee and I pay off our loans, that frees up almost $3,000/month, well in excess of what we could put away for retirement.

  33. 33
    Matt Says:

    I don’t get this desire to pay off debts w/o considering the costs of those debts. You’re freeing up future cashflow at the expense of present cash flow. You could easily be losing money over the LT with the rate differential. We have a 15yr mortgage at 4.5%, why in the world would I pay that off early? I’d be saying that I can’t earn more than 4.5% per year over the next 15 years. Unless we’re headed for another Great Depression, 1 yr CDs averaged over the next 15 years will easily beat that rate.

    Same thing with a car, it’s a depreciating asset but unless you live in the city you have to have one so if you can borrow money for it cheaper than the opportunity cost of using your own money why wouldn’t you?

  34. 34
    deRuiter Says:

    If you pay federal and state income taxes you are contributing to charity. Your hard earned tax dollars support welfare women with children by multiple fathers who pay no child support, you support free health care for illegal aliens at American hospitals, you contribute to the rebuilding of Iraq and Afghanistan so the miltants can destroy the rebuilt stuff, you pay for American troops in countries all over Europe so that those European nations do not have to supply standing armies and can finance their social welfare states. Don’t feel bad if you don’t cntribute EXTRA to charities while you are attempting to pay down your long term debt. If you pay off your long term debt, you will be protecting your self and your family, which your own government will not do. Paying taxes you also provide our Senators and representatives with magnificent health care and generous pensions for life, that is real charity considering what Congress does TO taxoayers!

  35. 35
    Jacinta Says:

    @Matt (#33), @John (#17), @Bryan (#16):

    Quoting Matt:

    “I don’t get this desire to pay off debts w/o considering the costs of those debts. You’re freeing up future cashflow at the expense of present cash flow.”

    The costs of those debts is a multi-level thing. There are the obvious costs such as the interest that accumulates, any yearly fee for having the debts (such as a credit card fee), and the effect of the debt on your credit score. On the other hand, there are the less obvious costs. Debt is risk. You know what your situation is right now, and the costs of having the debt now, but are you certain that the future will remain the same. If the interest rate on the debt increases, the debt costs more; any calculations you did back then might be invalidated. If you lose your job, the debt could become crippling. Serious debt may be a negative against you at the great new job you’re interviewing for. These are costs too.

    Curent cash-flow is known. Thus, making payments against debt in a known situation, frees not only future cash-flow, but it also reduces the risks of possible unknown future events. It’s a very sensible choice for anyone with dependents or who has other reasons to be risk adverse.

    John and Bryan discussed storing your extra payments in a side account rather than putting them straight into your debt. This has the advantage that these funds are liquid so if you do hit an unforeseen event, you have access to that money; rather than having to take on new debt. This is essentially the purpose of an emergency fund; and most financial bloggers, writers and advisors will tell you to build up a healthy emergency fund *first* (while paying the minimum on your debts) and only then start putting the extra into debts.

    Does this idea still have merit after you have an emergency fund? Well that’s an interesting problem. Will this actually earn you money or cost you money? How much of a cost are you willing to pay for this extra flexibility if necessary? You’ll be taxed on the interest you earn on your savings, so you need to account for that at your income tax level. There may also be account keeping fees to consider.

    If your debt is accruing an interest rate of 4.25% now; you need your extra money to be earning more than that. If you are in a 45% income tax bracket then you need to be getting an interest rate of 7.73% in an account with no fees in order for you to be breaking even. That’s a pretty stunning interest rate, and if you know a bank offering that in a savings account, please tell me! If you’re in a 30% income tax bracket you need 6.08% and if you’re in a 20% income tax bracket you need 5.32% (the maths is: required rate = debt rate / (1 – income tax rate/100) eg 7.73 = 4.25/(1 – 45/100) ). You also need interest in your savings account to compound at the same rate, or better than your debt. So if your debt compounds monthly, your account needs to do at least that. If your debt compounds daily and your savings account doesn’t, you need a higher interest rate still.

    I’m not sure that you’ll find that you *can* get a liquid, low-risk investment vehicle that will return a sufficient amount to make this a financially logical decision in most cases. Even if you do find an appropriate account that’s good enough (ie you’re not paying too much extra as a result), the moment your tax bracket, or the debt’s interest rate go up; your numbers will probably be invalidated.

    There’s the risk that having your debt repayment money liquid might incline you to spend that money, but that’s a self control issue I’m not going to go into.

  36. 36
    Jennifer Says:

    I just recently paid off a home equity loan (6 years early, which means $160 more a month that I’m not paying out to loans. Definitely worth paying extra on long term debt.

  37. 37
    Jennifer Says:

    Forgot to mention that I was fortunate to be able to pay cash for my house when I bought it and have never regretted it. No way would I keep a house payment in order to invest. Not having a mortgage frees up a whole lot of money, in addition to giving me the option of being able to work a job that I like but pays less money than a previous job that I hated but paid more.

  38. 38
    Bryan Says:

    @Jacinta (#35)Managing debt is situational. There are many factors to be considered before adopting a debt strategy. In my opinion,putting money in a side account to pay a debt is only apppropriate for a mortgage payoff plan, not any other debt. And, it’s not for everyone. Everyone’s situation, needs and level of self discipline are different so there is no blanket solution (that’s why these forums go off into many different directions).
    I came across a simple, common sense approach to cash flow management a few years ago, which I believe could be the basis for anyone’s strategy:
    First… Get a handle on where your money is going each month,and determine how much you have left over ( or determine how to have left over).
    Then commit the extra cash flow to a four step plan:
    Step 1: Create a Cash Cushion($8,000 to $10,000) for the little unbudgeted emergencies. This is Your bank, when the car needs repair or the boiler breaks borrow the money from yourself… pay cash. And pay yourself back. Until this account reaches your desired level and maintains that level all you extra cash flow goes here.
    Step 2: Get Debt Free: Whenever the cash cushion account is full apply all your extra cash flow to Eliminate non-preferred debt. A snowball approach will increase extra cash to apply to the strategy as you pay items off.
    Step 3: When the debt is gone…Establish Liquidity: six to twelve months salary saved. This is money you can get your hands on for investment opportunities or to carry you in the case of major interuptions to your income.
    When this level is reached (a fully funded cash cushion,no non-preferred debt, and one years salary in a safe, liquid place)financial stress will be greatly reduced or eliminated, life choices and decisions can be made without finance being the #1 consideration. Then…
    Step 4: Pay Off Your Mortgage: either by accelerating principal payments or building a side fund to accumulate to the pay off amount.
    Following each of these steps in order makes for a simple, tangible, effective plan for cash flow management. I often think of how much different things would be today if more Americans adopted such a strategy years ago… less foreclosures, less unemployment related stress, less personal panic.

  39. 39
    Glenn Says:

    @Bryan

    You are a little off base when you say:
    “If it will take 20 years to pay off a 30 year mortgage by paying an additional $150 per month toward principal, it will take 20 years of saving $150 a month to be able to pay off the mortgage at the same time , and still save ten years worth of interest. Either way, the “saved” interest is realized after the mortgage is paid in full.”

    Here is an example of the difference between paying extra every month as opposed to saving up to pay off in one payment:

    Mortgage: $100K
    Term 360 Months
    Interest: 5.5% APR
    Payment: $568

    If I saved $150 per month and waited to pay it down with one check, then it would take me 272 months to have enough money to pay off the remaining principal. I would save about $8,900 in interest.

    If I paid that extra $150 every month towards the principal then the mortgage would be paid off in 223 months and I would save $44,700 in interest. Also I would have the mortgage paid off 4 years earlier than the above method.

    That is a savings of over $35,000. For the two methods to equal out you would have to be getting a return of 6% on the $150/month saved. The most return I know of right now that is liquid and low risk is a reward checking account at 4%, capped at $30K.

    I would tend to agree with some of the posters here that a mixed method seems to give the best options for liquidity and interest savings. I currently put 1/2 extra money towards the mortgage and 1/2 in a taxable investment account. Worse comes to worse, I can always sell off securities to get cash if I need it.

  40. 40
    Bryan Says:

    @Glenn – We are working with alot of assumptions here. Assuming the writer took a 110K mortgage for 30 years at 5.5% and immediately applied the 8K tax credit to principal, he will be finished with the mortgage in a little over 25 years. If he pays an extra $150 monthly to principal he will be done in 16.9 (203 mths)years. If he put the $150 in an assumed 2.5% interest bearing account, he will have enough saved in 18.5 years(222 mths) to pay the mortgage off. A 19 month difference. The key point is having control and access of your money which the 2nd option provides.
    In regards to your strategy… The 1/2 and 1/2 plan is smart but what if worse comes to worse when your securities are running at a loss? You should keep your “worse comes to worse” money in a safe, liquid place (not securities and not as equity in your house).

  41. 41
    Nancy Says:

    Rosa, if you happen to see this..thank you for your encouragement! Guess what happened this week? I will be losing my health insurance, and the money that I had “freed up”, will now pay Cobra in Sept! There’s a reason for everything..

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