It's a good investment to use savings to pay high-interest debt


November 10, 1991|By JANE BRYANT QUINN | JANE BRYANT QUINN,1991, Washington Post Writers Group

New York -- Do you have a savings account that's earning a measly 5 percent? Here's how to get an instant double-digit return on that money, guaranteed.

Use it to pay off high-interest consumer debt. That's the single best investment available to most savers today.

Say, for example, that your credit-card balances cost you a burdensome 19 percent, while your savings are earning 5 percent. With that combination, you are losing 14 percent a year.

If you use those savings for debt-repayment, you'll raise the effective return on your money from 5 percent pretax to 19 percent after tax. That's an enormous gain.

You do need to keep a certain amount of ready cash in a checkingaccount or money-market fund. Traditionally, that's supposed to be three months worth of expenses.

I say scrap tradition. Keep only enough to cover your immediate bills and use the surplus to eliminate debt. Once you've gotten rid of your loans, you can rebuild your savings with the money you were previously wasting on interest and principal payments.

What if you think that you might lose your job? Lynn Hopewell, a financial planner with the Monitor Group in Falls Church, Va., thinks that, even in this situation, you should raid your savings to pay off debt.

If you aren't fired, he says, you'll have saved money on interest payments. If you are indeed fired and you need extra money, you have an easy fallback position. Simply re-borrow from the credit cards that you previously paid off. Thanks to your debt-reduction plan, your cards have become your safety nets.

Also in the spirit of debt reduction, large numbers of homeowners are trying to pay off their mortgages faster.

If they buy a new house, they're taking a 15-year mortgage instead of a 30-year one. If they have a 30-year mortgage, they're paying something extra each month, in order to reduce principal.

The sooner you retire your debt, the less loan interest you'll have to pay.

As an example, assume that you're holding a 30-year, $100,000 mortgage that costs you 8.5 percent. By repaying that loan in just 20 years, you'll save $68,500 in interest. And you'll build home equity faster, which is another safety net. If you suddenly need money, you could tap your home for a larger loan.

For those worried about their long-term job security, here's your fallback position: Open a home-equity line of credit, even if you don't need to borrow any money now. Look for a lender who will give you the line at a minimum cost. If you lose your job, you could tap the line for any extra money you need.

It's important, however, to get this credit well in advance. No bank will give you a home-equity loan after you've become unemployed.

In fact, even when you have an open line, you run the risk that the bank will hear about your job loss and decide to freeze your credit.

Some financial planners argue that it's dumb to accelerate mortgage payments. Your loan costs only 8 percent to 10 percent, tax deductible. You'd do better with a stock-owning mutual fund that might average 12 percent a year.

But numbers don't always influence feelings.

You might gladly trade high investment returns for more security in your life.

Furthermore, you might pay down the mortgage with money you would otherwise spend or bury in a low-interest bank account.

I can think of two situations in particular where quick-paying the mortgage makes a lot of sense.

* If you're self-employed. Your income is inherently speculative -- dependent, as it is, on your own good health and on the prosperity of your clients. To balance that risk, you might want to bend your efforts toward owning your own home, free and clear.

* If you're salaried and middle aged. In this economy, your company might eject you. If you've been slowly reducing your mortgage, you might now be able to refinance it at a lower level of monthly payments. That could save your home, if you're forced to take a new job at a lower wage.

When might you not want to accelerate?

If you're in your 30s and on your way up. You're better off putting your money into a tax-sheltered retirement plan, invested in stocks for the long term.

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