Pay­ing off credit card debt

The Record (Troy, NY) - - BUSINESS -

Read­ers may won­der why a col­umn that usu­ally ad­dresses is­sues re­gard­ing in­vest­ments and the econ­omy is di­gress­ing into one that per­tains more to con­sumers. The rea­son is that we have re­cently re­ceived sev­eral tele­phone calls from lis­ten­ers to our ra­dio show on 810 WGY with in­vest­ment port­fo­lios, but who also have ac­cu­mu­lated siz­able credit card debt. Their ques­tions are twofold, given the level of their debt as well as the in­ter­est rates be­ing charged, should they pay off the debt with other as­sets and, if so, where to with­draw the as­sets from to pay off said debt.

Prior to re­spond­ing to their con­cerns and per­haps the con­cerns of the read­ers, some facts need to be de­ter­mined and some ques­tions need to be an­swered. The first re­quest that we have for the client is that they spec­ify the out­stand­ing bal- ance of each spe­cific card (as­sum­ing there is more than one) and the in­ter­est rate is be­ing charged by each lend­ing in­sti­tu­tion. The sec­ond con­sid­er­a­tion re­volves around the fi­nan­cial re­sources avail­able to tap should the client wish to pay down or pay off the bal­ances on the credit cards. Re­gard­ing this is­sue, the tax ram­i­fi­ca­tions and with­drawal of funds thereby re­duc­ing the liq­uid­ity of the client are both con­sid­er­a­tions.

The most ap­pro­pri­ate man­ner in which to per­haps help the read­ers of this col­umn re­gard­ing their credit card debt is to cre­ate sev­eral sce­nar­ios and out­line our rec­om­men­da­tion to each sit­u­a­tion. Each sce­nario as­sumes that the client has credit card debt that they wish to elim­i­nate through tap­ping other avail­able sources.

Prior to out­lin­ing each sce­nario, let us first re­mind read­ers that the av­er­age in­ter­est rate be­ing charged by credit card is­suers is well in ex­cess of the longterm his­tor­i­cal nor­mal re­turns of the stock mar­ket of ten per­cent and the fact that out­side of uti­liz­ing the credit cards for busi­ness pur­poses, in­ter­est charged by the lend­ing in­sti­tu­tions are not tax de­ductible.

Sce­nario 1, as­sumes credit card debt of $10,000 owed by an in­di­vid­ual or cou­ple who are ap­prox­i­mately 45 years of age. They cur­rently have suf­fi­cient eq­uity in their home to pay off their credit cards via a home eq­uity loan and have bal­ances in an em­ployer spon­sored pen­sion plan such as a 401(k) or 403(b) plan. Given the above, we rec­om­mend that the client with­draw the bal­ance owed from their home eq­uity loan and set them­selves up on a pay­ment sched­ule not to ex­ceed five years. We sug­gest this course of ac­tion due to the lower in­ter­est rate of­fered by a home eq­uity loan when com­pared to credit card is­suers and the fact that the in­ter­est charged for the home eq­uity loan may be tax de­ductible while the in­ter­est charged by the credit card com­pany is not. Re­gard­less of the age of the client, we gen­er­ally rec­om­mend tap­ping the home eq­uity rather than cre­ate a tax­able sit­u­a­tion that would re­sult should the client with­draw funds from an In­di­vid­ual Re­tire­ment Ac­count (IRA) or other qual­i­fied in­vest­ment. The only ex­cep­tion would ap­ply to clients who have reached the age where they must take manda­tory dis­tri­bu­tions from their IRA. In this case, it is of­ten quite fea­si­ble to use these with­drawals rather than the home eq­uity.

Sce­nario 2, as­sumes credit card debt of $10,000 owed by an in­di­vid­ual or cou­ple who are ap­prox­i­mately 45 years of age. They cur­rently have suf­fi­cient eq­uity in their home to pay off their credit cards via a home eq­uity loan, have bal­ances in an em­ployer spon­sored pen­sion plan such as a 401(k) or 403(b) plan and have non­qual­i­fied ac­counts (tax­able bro­ker­age ac­counts or mu­tual funds). Given the above, we rec­om­mend that the client with­draw the bal­ance owed from their non-qual­i­fied ac- counts to sat­isfy the credit card debt. The money should be pulled from the ar­eas of these ac­counts that have the least po­ten­tial for growth, namely money mar­ket funds and/ or bond funds. In fact, gen­er­ally speak­ing, re­gard­less of the age of the client, this course of ac­tion is prefer­able to oth­ers. One note, be cer­tain to re­bal­ance your port­fo­lio back to your in­tended per­cent­ages.

Sce­nario 3, as­sumes credit card debt of ap­prox­i­mately $10,000 owed by a re­tired in­di­vid­ual or cou­ple and who are ap­prox­i­mately 65 years of age. They cur­rently have suf­fi­cient eq­uity in their home to pay off their credit cards via a home eq­uity loan, have bal­ances in an IRA, but have no other as­sets. Fur­ther­more, they do not have suf­fi­cient monthly in­come to pay for the debt. Once again, we sug­gest the home eq­uity loan to sat­isfy the credit card debt. How­ever, this none­the­less does not elim­i­nate the is­sue of cash flow. We there­fore gen­er­ally rec­om­mend that the client with­draw money from their IRA to pay the monthly home eq­uity charges, but amor­tize that loan over a five year pe­riod thereby re­duc­ing the tax bur­den re­sult­ing from the IRA with­drawal while po­ten­tially ben­e­fit­ing from the in­ter­est de­duc­tion from the home eq­uity loan.

We could cre­ate dozens of sce­nar­ios, but tried to ad­dress those we thought most com­mon. One note of cau­tion, should you pay off all credit card debt only to build it back up, then our plan will not work. In fact, you have spent fu­ture in­come, some of which per­haps you are not able to af­ford.

Please note that all data is for gen­eral in­for­ma­tion pur­poses only and not meant as spe­cific rec­om­men­da­tions. The opin­ions of the au­thors are not a rec­om­men­da­tion to buy or sell the stock, bond mar­ket or any se­cu­rity con­tained therein. Se­cu­ri­ties con­tain risks and fluc­tu­a­tions in prin­ci­pal will oc­cur. Please re­search any in­vest­ment thor­oughly prior to com­mit­ting money or con­sult with your fi­nan­cial ad­vi­sor. Please note that Fa­gan As­so­ci­ates, Inc or re­lated per­sons buy or sell for it­self se­cu­ri­ties that it also rec­om­mends to clients. Con­sult with your fi­nan­cial ad­vi­sor prior to mak­ing any changes to your port­fo­lio. To con­tact Fa­gan As­so­ci­ates, Please call 518-279-1044.

Chris + Den­nis Fa­gan

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