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Question From Money Crashers Reader: What Should I Pay Off First?

By Erik Folgate

Here is a question from a Money Crashers reader. She is in a great situation, because she has a nice lump sum of money, but she doesn’t know what to do with it.

My home is worth about $375000 and I owe $62000 on it. My credit card debt is $21000 ($11000 at 3.99% for life of loan and $10000 at 10% until 11/08) and school loans of $10000. I am recently widowed and am struggling month to month with my bills. I have a lump sum of $80000. Should I pay off the credit cards and school loans which would decrease monthly payments by about $700? Thank you.

My Answer: First of all, thanks for being a reader. I answer all reader questions based on what I would do. It’s merely my opinion and you can take it for what it’s worth. I always answer these questions by evaluating what plan of action will help you reduce the most amount of risk in your life. With an $80k lump sum, I would definitely pay off the the credit cards and student loan first. You’ll be debt free, except the house, and you’ll free up a huge amount of monthly income. That extra $700 will be great to have for a single mom who is working paycheck to paycheck right now. With the remaining amount, I would set aside four to six months worth of monthly expenses for an emergency fund. Then, if you haven’t started saving for retirement, open up a ROTH IRA and fully fund it for 2008. You’ll, still probably have about $25k after all of this. You can then invest the rest in index funds that follow the S&P 500 such as the Vanguard 500 or pay down some of your mortgage. If you’ve done all of the other steps first, what you do with the extra $25k is not a huge deal. Even if you wanted to set aside $5k for a vacation or to just have some fun with, that’d be fine too!

Readers, please post your suggestions with what this reader should do given her situation.

Erik Folgate
Erik and his wife, Lindzee, live in Orlando, Florida with a baby boy on the way. Erik works as an account manager for a marketing company, and considers counseling friends, family and the readers of Money Crashers his personal ministry to others. Erik became passionate about personal finance and helping others make wise financial decisions after racking up over $20k in credit card and student loan debt within the first two years of college.

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Comments

  • Bill

    First of all, let me offer you my condolences. I know what you’re going through. My Mom was in the same situation when I was 15 and my brother was 7. But we didn’t have a life insurance payout (I’m guessing that your $80,000 lump sum is from life insurance.) The good news is that the insurance payout is tax-free because it’s not income.

    As for your debt, I would suggest that you pay off the $10,000 @ 10% first.
    Then pay off the $21,000 @ 3.99%.
    This will leave you with $49,000.

    I would look at your mortgage to see how much of it you’re deducting on your taxes. It might not pay for you to pay off your mortgage because you might be getting a great deduction from it. Also, if the mortgage was just in your husband’s name, you might want to talk to your estate attorney to see what options you might have about paying it off/canceling it. Remember, if you pay off your mortgage you lose that deduction after the year your mortgage is paid off.

    I would then suggest that you contact your student lender and inquire about canceling your student loan based on economic hardship. If you’re recently became widowed, have kids to raise and are struggling month-to-month, you would probably qualify. You’ll have to fill out forms and show your income. But it could save you $10,000. And right now, every dollar counts. Remember, the insurance payout that you got does not count as your income.

    I would then really think about what you want to do with the remaining $49,000.
    You don’t want to gamble with this. You can use it to build your next egg. But in a volatile market like this, your best bet might be to play it very safe and invest some of it in tax-free treasury bills/bonds until the market really starts to rebound and moves upwards for at least 6 months.

    I would not invest any of your money in regular stocks/mutual funds or ETFs right now for 2 reasons.

    1. You want to hold on to that $49,000 because it could be the last big pay out that you ever have. And you want be very careful with it because you want it to provide you with security for a very long time.

    2. The market is too volatile right now. If you invest $10,000 and it goes down to $8,000 (a loss of 20%. $2,000 is 20% of $10,000), your $8,000 investment now needs to rise 25% to regain the $2,000 that it just lost to get back to even (25% of $8,000 = $2,000). Remember, it always takes more performance for an investment to rise than it does to fall.

    You can also open a Roth IRA and deduct your investment from your taxes next year (if you’re not already in a 401k plan or retirement plan.)

    Whatever you do, just make sure that you work out the numbers for every scenario before you commit to investing. This way, you’ll know exactly what you’re saving.

    Good luck.

  • Nancy Bodzioch

    Thank you both so much for the great advice. I was leaning that way but wanted to be sure I was on the right path.

  • kobe

    Well everyone has their own presumptions or lookout which is according to be the best in their view. What I feel for such situation the best option would definitely going to be debt consolidation loan. Why I would prefer debt consolidation loan is because it’s going to merge all your loans making it one and giving you the ease in making monthly installments as the interest rates are quite low. The other most advantageous upside of debt consolidation loan is that it simply increases your credit score; being merging all the loans you are left with one single loan rather different other loans. I would surely prefer debt consolidation loan for any such situation where there are more than one loan, else the money shop can also give you best assistance to overcome such scenario.

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