How Intensely Should You Destroy Your Debt?

Have you read the stories about crazy people who paid off their debt as quickly as possible but suffered majorly in order to do so?

I’ve come across some insane stories of people who have cashed out their 401(k)s and paid huge penalties to pay off low interest rate student loan debt.

That’s pretty extreme. I personally wouldn’t recommend it.

It does raise an interesting question though.

Where do you draw the line between extreme debt payoff at all costs and a healthy dose of pain you need to suffer due to the reality that you’re in debt?

How Crazy Fast You Must Attack Your Debt

The first major factor in determining how crazy fast you need to attack your debt is the interest rate and type of debt you have.

If you have a payday loan with insane interest rates, you need to destroy your debt like it is your mortal enemy. There are no excuses. You must realize that these types of debts can destroy your life in no time flat and lead you down the path of financial ruin.

Do whatever you can to get rid of these loans as fast as possible.

Credit cards are another type of debt that you must take seriously as they normally carry a high interest rate. You’d want to make some fairly extreme financial moves to get rid of the high interest rate credit card debt, but there are a few things I’d probably avoid doing.

For instance, I wouldn’t pull money out of my 401(k) to get rid of this debt. You likely lived above your means in order to get into credit card debt, so it is time to pay the price now and live a not so plush life until it is gone.

Where Debt Destruction Gets A Bit Fuzzier

Things get a bit fuzzier after payday loans and credit cards. How intensely you should destroy your debt varies greatly depending on your personal situation and your intolerance for debt.

There are some types of debt, such as low fixed interest rate car loans, student loans and mortgages that I probably wouldn’t pay off quickly. These types of debt should all be carefully considered before you incur them as you must only incur them within reason.

For instance, I’d only off pay car loans slowly if you’re using arbitrage to earn extra interest with the cash you would have used to pay for the car by keeping it in a high interest bank account. After all, I don’t advise buying cars you couldn’t pay for in cash.

Student loans are unfortunately another type of evil debt that many people face. If your interest rates are fixed at or below 4% I wouldn’t be in a rush to pay them off. In fact, I’d probably pay them off as slowly as possible, but that’s just me.

If your student loan interest rates are 6% or higher I’d probably try to pay them off more quickly than the normal term of the loan agreement. You don’t have to go all or nothing toward these types of debt unless the interest rates or total debt owed are insane.

The Largest Debt You’ll Likely Ever Incur

Mortgages are extremely common when buying a house as very few people can afford to pay cash.

As long as you’ve bought a house that was well within what you can afford and your fixed interest rate is 5% or lower, I wouldn’t be attacking your mortgage debt unless it keeps you up at a night.

Just make sure that you’re not paying PMI, which normally requires putting down 20% when you first buy your house.

However, if you aren’t going to invest the money that you could use to pay down your mortgage faster, then you may want to consider paying down the debt.

Paying down debt increases your net worth and reduces your the amount you owe to others, while spending the extra money frivolously won’t further your financial goals.

Make sure you’re always working toward bettering yourself financially.

What is your take on how intensely people should destroy debt? Does it matter what type of debt it is?

The Definitive Way To Know If You Should Pay Off Your Mortgage Early

Want to be mortgage free? Looking forward to the day you complete your mortgage payoff? There may be a better way to allocate your money. It may be better to invest money instead. Learn how to figure out if you should invest or pay off your mortgage through our easy one step process.Paying off your mortgage early can seem like a great idea.

However, others argue that if you invest the money you would have used to pay your mortgage off early, you will likely end up with a higher net worth in the end.

Consider the following situation to figure out whether paying off your mortgage early is the right decision for you.

It should easily show you which option you prefer.

What Would You Do In This Situation?

Let’s pretend you owe $200,000 left on your 30 year 4.0% fixed rate mortgage. You have 25 years of payments left.

Somehow you come across a big stack of cash or, more realistically, get a check for exactly $200,000, just enough to pay off your mortgage.

What would you do with it? If you only had the following two options, would you pay off your mortgage or invest the money?

The answer to this question should tell you whether or not you should pay your mortgage off early.

Pay Off Your Mortgage Early

Paying off your mortgage early would be the safer option for most people. You would get a guaranteed 4.0% rate of return on your money and you wouldn’t have to worry about having a mortgage payment ever again. Granted, you’d still have to pay for insurance, taxes and other housing expenses, but you’d never make another interest and principal payment again.

Another point worth serious consideration is the fact that a home’s value will not remain static. Historically, housing prices have kept up with or exceeded the rate of inflation, which is good news if you pay off your mortgage.

However, recent memory reminds us that housing prices can crash, too. Due to the fact that a buyer and a seller must come to an agreement for a transaction price, when prices drop you could lose a lot more than you would think should you need to sell your home quickly.

Of course, using the cash to pay off your mortgage has downsides as well. By paying off your mortgage in full, you’ve locked up your cash in an illiquid asset.

If you need some of that money for an emergency or any other reason, you’ll have to sell or remortgage your house. Neither of these options can be done quickly and both require major expenses.

You’ll also lose out on the mortgage interest tax deduction. However, this tax deduction is really only for rich people anyway, so it may not affect you.

Invest The Money

Investing the lump sum is the other option. Investing has the potential to give you an overall higher return as stock market returns have generally outpaced 4% by a fair margin over long periods of time.

This option also allows your money to be more liquid should you need to access some of it for any reason. While selling when stocks have lost value would be a real possibility, you could at least only sell part of your investment rather than all of it like you would have to with a house.

Of course, human tendencies of buying high and selling low could easily demolish your return. If you aren’t a skilled investor, and by that I mean leaving your investments alone during market crashes, paying off the mortgage early may produce more reliable returns.

You would still be stuck with a monthly mortgage payment, but if you ever changed your mind later you could always sell your investments and pay your mortgage off at a later date. 

Considerations That Must Be Taken Into Account

Keep in mind, this whole analysis depends heavily on a couple factors that not every person would be able to consistently enact.

First, the person must invest every single penny they would have used to pay off their mortgage early. Many people don’t feel the same passion for investing that they feel for paying off debt.

People may put more toward paying off their mortgage than they would put into their investments. If that’s the case, it may make sense to pay your mortgage off early.

The second factor you must consider is your risk tolerance. If you don’t feel comfortable holding investments over a long time period through both bull markets and stock market crashes, paying off your mortgage debt is a safer, guaranteed return. If you sell when markets crash, you could end up with less money in the end than if you just paid your mortgage off early.

Finally, if your mortgage interest rate is anywhere above 6% or you have a variable rate mortgage or some other type of exotic mortgage, paying off your mortgage early may be your best move. Fixed rate mortgages reduce interest rate risk, allowing you to invest over long periods of time and grow wealth through arbitrage.

What Will We Do With Our Mortgages?

In the end, it really depends on your personality and risk tolerance to determine whether or not paying off the mortgage early is the right move for you.

Personally, I don’t believe we will be paying off our mortgages early. However, if we do, it will likely be after we’ve invested enough money to be able to pay the mortgage off with the hit of one sell button.

Of course, we’ll have to remember to factor in the taxes on our investment gains or else we would be hurting when we filed our tax return the next year.

Which camp do you fall in? Would you want to pay off your mortgage early or do you take the more logical approach of letting investments grow? Where do you think people would mess up the most in each situation? I’d love to hear your thoughts in the comments.

Never Make A Car Payment Again After Using This Easy Trick

Want a lower car payment? How about no car payment at all? Believe it or not, you can get rid of your car payment for good and be car payment debt free. You only need to make one change. Find out what it is on MoneyManifesto.com. This life hack will amaze you.Car payments are a major category in the budgets of most Americans. In fact, they’re just behind mortgage or rent payments in most cases in terms of total expenditures.

Sadly, some people are taking out car loans for as long as 96 months… That means it would take 8 years to pay for a car. Insane!

Luckily, you don’t have to fall victim to the never ending cycle of car payments.

You can escape car debt forever by changing just one simple thing when it comes to car ownership.

Own Your Car Longer – It’s That Simple

The only change you need to make to escape car payments, in most cases, is the length of ownership of your car.

Really, it is that simple. Not following? Here’s how it works.

Let’s say the typical American takes out a 60 month (5 year) car loan when they buy a new car. Let’s say you got an amazing deal and only pay 0.9% interest on that car loan.

Finally, let’s pretend your loan was for a $30,000 car. Using this situation, your payment would be $511.52 a month, or roughly $500 for simplicity’s sake.

Instead of ditching your car when you pay it off after five years, just keep the car. Continue making your normal car payments, but instead of sending them to the bank to pay off your loan, send them to a savings account solely dedicated to your next car purchase.

After just one extra year of car ownership, you’ll already have $6,000 set aside for your next car. Holding onto the car for 2 years longer would leave you with $12,000, 3 years would be $18,000, 4 years would be $24,000 and 5 years would be $30,000.

That doesn’t even count any interest you may earn on the money that you’ll keep in a savings account.

How Long Will Your Car Last?

While most cars should last at least 10 years and well over 100,000 miles, not all will end up lasting quite that long while others will last even longer. Additionally, you’ll likely have at least one hefty maintenance bill sometime during the extra years you hold on to a car.

As far as repairs go, take them out of the money you have saved for a new car if you have to. It is much cheaper to spend $1,000 to repair a car to make it last another year than to spend $30,000 on another new car and have 60 more months of $500 payments. It may put you behind schedule a little bit for your next car, but that’s no big deal in the big scheme of things.

But what do you do if you HAVE to get a more reliable car before you can afford to buy another new car in cash? You have two options. The first is preferable, but the second is acceptable as you work toward car debt freedom.

Only Buy A Car You Can Afford To Pay For In Cash

The best thing to do in the situation where you must buy a new car is to buy a new to you car you can afford to pay for in cash. Even if you only have $5,000, or one year’s of payments, set aside, you can get a decent car that will get you around town.

The best part of using this method is the fact that you won’t have a car payment and you can continue putting your $500 a month into a new car fund. Since a cheaper car is likely older, you will lose less money in depreciation over the time you own it.

When you’re ready, you can sell your new to you car and combine the proceeds with your savings account and purchase an even more expensive car down the road if you wish. Of course, if you find out that the $5,000 car works just fine for you, you don’t have to spend a penny more until you need another new car. Then you can divert that extra $500 a month to other savings goals.

Get The Smallest Loan Possible If You Must

Not everyone will have $5,000 in cash to buy a decent reliable car. If you find yourself with no cash, only buy the least expensive reliable car you can find. This will keep your car payment as low as possible and allow you to continue saving for a better one as soon as you pay off that tiny car loan.

Once the loan is gone, simply continue saving for a new to you car and then you can sell the current car and use your savings to buy a nicer car if you wish, just like with the example above.

How To Accelerate Your Car Debt Freedom Starting Today

So now that you understand how to work toward never having a car payment again, you’re probably wondering if there is any way you can accelerate this process. The answer is simple.

You definitely can accelerate freedom from car debt if you’re willing to make changes.

Sell Your Car Today

Instead of waiting until your current car loan is paid off, you can make a big change today and sell your car. Hopefully you have equity in your car (can sell it for more than you owe on it), but even if you don’t, it makes sense to get rid of your giant car payment as soon as possible.

If you’re underwater on your car, save up enough money to be able to cover the difference between what you owe and what the car is worth. Once you have enough money, sell the car and pay off the loan.

Next, take whatever money you may have left over from your car sale and follow the instructions above. If you have enough cash to buy a reliable used car, do that. If not, get as small of a car loan as possible and work toward getting a nicer car down the road, if you wish.

By selling your car today, you vastly accelerate the process by getting rid of your current expensive car instead of waiting until you pay it off. This will allow you to start saving for a new to you car faster and live without car payments for the rest of your life even more quickly.

Living life without car payments isn’t difficult. Unfortunately, most people are impatient or want a nicer car than they can truly afford. Don’t be a slave to car payments your whole life. Be patient, buy cars you can truly afford and never have a car payment again.

Do you have a car payment? Or have you escaped car payments for the rest of your life? I’d love to hear your thoughts about the process of escaping car payments in the comments below.

P.S. You get bonus points if you take the extra money you’re saving and put it toward retirement.

Save Or Invest Your Old Debt Payment When You Pay Off Debt

Just get out of debt? Finishing your debt payoff is a great feeling, but what do you do with your old debt payment money? If your debt snowball got large, that could be a lot of money. Should you save money or invest money or spend on travel? Find out exactly what to do on MoneyManifesto.com.Paying off debt is exciting! You’ve finally conquered your credit card, car loan, student loan or even mortgage payments that you’ve been paying for years.

No more sending money you’ll never see again to the banks. But what do you do with the money you used to send in every month?

You Shouldn’t Spend Your Old Debt Payments

You no longer have to worry how to pay off your debt. You’ve even freed up some cash flow in your monthly budget.

You’ve adjusted to your debt payments over time. You make them every month, so you don’t even consider them as money you can spend in your monthly budget anymore.

However, now that the cash flow from these old debt payments no longer has to go toward paying down debt, people automatically assume they can spend it.

That can be a mistake if you haven’t followed the guidelines below.

This new found money is a great opportunity to continue bettering your financial position. You need to make sure you take full advantage of this opportunity.

So What Should You Do With Your Extra Cash Flow?

If you’ve just paid off a debt, there is still a good chance you owe money on other credit cards, car loans, student loans or mortgages.

Personally, the first thing I’d do with my extra cash flow is pay off other high interest rate debt. Take the exact amount you used to pay toward your old, paid off debt and apply it to your other debt obligations.

Some people will advocate that you use the debt snowball or debt avalanche method when applying extra money toward your debts. You can learn everything you need to know about the debt snowball method here and the debt avalanche method here.

What should you consider high interest rate? Definitely anything over 8% and you can even go as low as 6% in many cases depending on the situation.

Don’t Have High Interest Rate Debt?

Congrats! Not having high interest rate debt is a pretty awesome place to be in. However, your finances probably aren’t bulletproof yet. Do you have an adequate emergency fund?

I think most people should have anywhere from 3 to 12 months worth of expenses (not income) in an emergency fund depending on their financial situation. If you haven’t met your personal emergency fund goal, your old debt payment should be going straight to your emergency fund.

I personally keep my emergency fund at an online bank where it is a bit harder to access my money, like Capital One 360 (read more about it and learn how to earn a $50 bonus in our review here).

The best part is you can set up automatic transfers to your emergency fund account on a recurring basis, just like your payments with your now paid off debt! This way you can be sure that you won’t be tempted to spend the money.

Already Have An Emergency Fund?

Having an emergency fund fully funded is a rarity these days, so good for you. However, I’m guessing you still aren’t financially bulletproof yet. How are you doing with your short term goals and investments such as retirement accounts?

Shore Up Your Short Term Goals

The next step I’d take is making sure that I’m on track for any short term goals that will require spending money in the near future.

You don’t want to go back into debt if you’re planning on buying a replacement car in 2 years. Instead, start applying your old debt payment to a special savings account for your next replacement car or other short term goal.

Get On Track With Your Retirement Plans

I’d also check to make sure my retirement is on track. If you aren’t on track, start contributing more money to a regular or Roth IRA. Alternatively, you can simply increase your contribution percentage to your 401(k) or other workplace sponsored retirement plan to match what your old debt payment was.

Even if you’re doing well with your retirement savings and investments, you may want to consider kicking some of your old debt payment money into a higher contribution rate. You may be able to retire earlier than you originally thought.

Invest In A Taxable Account

If you don’t want to invest any more money in retirement accounts, you can always invest in taxable accounts. Most people are scared of investing, but most of the wealthy didn’t get rich until they started investing.

Whatever you do, don’t let inflation eat away at your money as it sits in cash in a low interest checking or savings account.

Financially Bulletproof? Spend It

If you’re doing awesome and on track with all of your other goals, then you might be able to spend that recently retired monthly debt payment. Just be careful because you could be inflating your lifestyle. You’ll have to reexamine all of the above with that higher lifestyle cost if that’s the case.

There’s nothing wrong with spending money if you’re in good financially shape and you do so consciously. Just don’t let that old debt payment turn into mindless spending.

So, what will you do with your old debt payment? Where are you on the list of steps above? Will you be paying off other debt or investing?

Photo by: AMagill Text added by: Lance Cothern

Mortgage Interest Tax Deductions Are Only For Rich People

Want to save money on your taxes? Think owning a house helps you get a large tax refund because of the interest you pay on your mortgage? Paying interest to save on taxes is a bad tax return tip. While some people save a small amount of money with the mortgage interest tax deduction, it mainly benefits the rich. Maybe paying off your mortgage isn't a bad idea? Find out my thoughts!Sadly many people think they’re saving a ton of money on their taxes when they buy a home.

Why? They think they’re going to get a huge tax break with the mortgage interest tax deduction.

Those people are in for a shock when they complete their first tax return after being a homeowner.

The mortgage interest tax deduction may have originally been for the average family, but it has always provided more benefit the rich more.

Why? The mortgage interest tax deduction allows you to deduct the interest paid on a mortgage on your primary and/or second home based on mortgage debt of up to $1,000,000. You can also deduct the interest on up to $100,000 of home equity debt.

The normal American cannot afford anywhere near these limits stated in the mortgage interest tax deduction rules. Even if an average married person can afford a $300,000 home, the tax deduction won’t even help you one bit unless you have other itemized deductions you can claim.

How can this be? The following example may shock you.

A $300,000 Home And No Mortgage Interest Deduction For Some

Let’s say you buy a $300,000 home. You put 20% down, so you’ll have to take out a mortgage for $240,000. Today you could easily get a 30 year fixed rate mortgage with a 4.5% interest rate if you have good credit. In the first full year of paying off your mortgage, you’ll only pay $10,720.29 in interest payments.

Unfortunately, that won’t help many people one bit. Why?

Itemizing Deductions Replaces Your Standard Deduction

When you itemize your deductions, you give up the standard deduction. In 2014, the standard deduction is $12,400 for married couples filing jointly and $6,200 for those filing single. 

If you’re married and have no other itemized deductions, which is admittedly unlikely, you won’t even itemize because the standard deduction would give you a bigger tax benefit. Your mortgage interest tax deduction is essentially useless in this case.

If you’re single and have no other itemized deductions, you’ll actually get to itemize your deductions. However, don’t think for a second you get $10,720.29 in deductions as your benefit. Instead, the only tax deduction benefit you’ll gain is the amount by which your itemized deductions exceed your standard deduction.

So, as a single person, you’d get $4,520.29 in additional deductions due to the mortgage interest deduction. If you’re in the 25% tax bracket, this would save you $1,130 in federal income tax. As a married person, you’d get no benefit at all. Not one penny saved in federal income tax. Sad! [Related: How Tax Rates Work In America]

Keep in mind, you pay the most interest in the first year of your mortgage. Every year after the first year, your mortgage interest tax deduction will shrink because you’re paying less interest each year.

On top of that, the standard deduction generally increases with inflation. That means your benefit will shrink even more as inflation increases the standard deduction.

How The Mortgage Interest Tax Deduction Favors The Rich

Let’s pretend I’m rich and am swimming in money. I’ve decided to take out the maximum mortgage amounts allowable under law to maximize my mortgage interest tax deduction. I have $1,000,000 in mortgage debt at 4.5% and a $100,000 home equity loan, also at 4.5% both on a 30 year amortization schedule for simplicity’s sake.

With this maximum level of mortgage debt, I’d pay $49,136.97 in interest that would qualify for the deduction. I’d assume because I can afford such a large mortgage, I’m probably in a higher tax bracket. I’d likely have a 28% or 33% marginal tax rate depending how much of my income is derived from wages vs investment income.

As a single person, I’d get an additional $42,936.97 in deductions. At the 28% tax bracket I’d save $12,022.35 in federal income tax and at the 33% tax bracket I’d save $14,169.20 in federal income tax.

As a married person, that would result in an additional $36,736.97 in deductions. At the 28% tax bracket I’d save $10,286.35 in federal income tax and at the 33% tax bracket I’d save $12,123.20 in federal income tax.

The rich person who can afford $1,100,000 in mortgages gets to save anywhere from $12,000 to $13,000 more in federal taxes paid than the normal person with a $240,000 mortgage! That’s messed up! Why are we subsidizing homes for the rich? Why not help the normal Americans looking to buy a home more?

Granted, they are paying more in interest to the bank, but why subsidize it?

Normal Americans Used To Benefit From The Deduction

Normal Americans used to be able to benefit more from the mortgage interest deduction. Unfortunately, that’s because they were paying a lot more in interest.

Mortgage rates are currently at one of the lowest points in history. If you had the same size mortgage now vs 20 years ago, you’d be paying less in interest today.

Paying less in interest is a much better deal than getting a bigger tax deduction. Tax deductions only reduce your taxable income, not the tax you pay, you only save a fraction of each dollar you pay in interest on your tax bill. However, let’s run the numbers real quick.

In 1994, mortgage rates were as high as 9% on a 30 year fixed rate mortgage, essentially double today’s rates. On a $240,000 mortgage, you’d pay $21,533.46 in interest in the first year.

For a single person in the 25% tax bracket that would result in a $3,833.37 reduction in their federal income tax due and for a married couple filing jointly, also in the 25% tax bracket, it would result in a $2,283.65 reduction in their federal income tax due.

But The Rich Have Always Had A Larger Benefit

While normal Americans used to benefit more from the mortgage interest tax deduction, the rich have always received a larger benefit. Using the same 9% interest rate, a rich person with $1,100,000 in qualified mortgage debt would see a larger reduction in their tax bill. They would pay $98,695.02 in interest in their first full year of their mortgage.

For a single person in the 28% tax bracket, their federal taxes would be reduced by $25,898.61 and for a single person in the 33% tax bracket, their federal taxes would be reduced by $30,523.36.

A married person in the 28% tax bracket would see their federal taxes reduced by $24,162.61 and in the 33% tax bracket they’d see their taxes reduced by $28,477.36. 

Keep in mind, there are many other calculations that go into tax calculations and the rich do have their itemized deductions phased out at a certain point. Normal Americans will likely have other deductions they can itemize, too. [Related: Be Wary Of Year End Charitable Contribution Phone Calls]

No matter what, the home mortgage interest tax deduction is no longer as useful as it once was for the ordinary American. It has always benefited the rich more.

That said, why is the limit on mortgage debt $1,000,000 or $1,100,000 with home equity debt? Wouldn’t something like a $500,000 still help the average American while not subsidizing housing for the rich? I’d love to hear your thoughts! Let me know what you think in the comments below.

Photo by: LipBomb Text added by: Lance Cothern