Long-Term Debt: Quality Over Quantity

Think you’re drowning in too much debt?  If you can’t comfortably pay it all off before you’re ready to retire then you probably are.  You should also be able to continue saving for retirement while you are in the process of “retiring” all of your long-term debts.  If this sounds impossible to accomplish then you have debt overload and need to take corrective action to free yourself from the cycle.  The amount of debt that you take on should be based on your age as well as your annual income.  By the time most Americans reach their forties they have accumulated long-term debt equivalent to 3 times their annual income.  This debt is then slowly paid down but still averages 1 to 1.5 times their annual income by the time they’ve reached their sixties.  We as Americans need to wean ourselves from long-term debt and stop the cycle of over-consumption if we hope to retire debt free in our sixties.  The goal should be to maintain an amount of debt equal to 1.5 times your annual income once you’ve reached your forties and to continue to reduce, and not add to, your debt from that point forward. 

There is a relatively simple thing you can do to improve the quality of debt you currently have that will help you to eliminate it more efficiently and increase your tax advantage.  The place to begin is with your home.  While your home equity should never be used as a cash register for making frivolous consumer purchases, converting high interest non-deductible debt into a home equity line of credit (HELOC) makes sense on many levels:

• Tax Treatment – the interest paid on a secured home equity line of credit (HELOC) is tax deductible, generally up to $100,000 beyond your first mortgage or acquisition loan.   

• Superior Rates – a secured loan, particularly those secured against a primary residence, almost always offer the best interest rates and financing terms.   HELOCs typically have a 10 year draw period during which you can access the funds and then the draw period is over and the repayment period begins so the loan is fully amortized and paid off 15 years after the draw period has ended.  Most HELOCs are offered without prepayment penalties if you wish to pay it off even sooner.

• Attractive Fees – many HELOCs are available at no cost.  Of course they charge interest but “no cost” generally means no upfront points or fees to open the account.  Many lenders will offer even better terms if you open a checking account and agree to sign up for automatic payments to be transferred from your account to pay the loan.

• Simple to Consolidate – the goal of course is to use this low rate, tax advantaged HELOC to pay off your less attractive, higher interest consumer debts.  But you want to be smart about implementing this concept and not use your home equity as an endless source of cash to make consumer purchases.  This would be a fatal error in the plan that would not only threaten your ability to retire but could also put your home in jeopardy as well.

Always consult with your tax advisor regarding your own individual circumstances.

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