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Cut your debt now while rates are low
By Greg
McBride • Bankrate.com
Do you feel poorer with the arrival of every
brokerage or 401(k) statement? There is a way, other than winning
the lottery, to increase your net worth in this environment: Start
reducing your debt.
Net worth is the difference between what you own and
what you owe. Just as corporations have two ways of increasing the
bottom line -- by growing revenues or reducing expenses -- consumers
can also get a boost by cutting debt. Call it "addition by
subtraction" if you wish.
Lower interest rates mean more of a given payment
is applied to the principal. The more applied to the principal balance
this month, the lower the balance and subsequent interest charges
next month. With less of the payment being eaten up by interest
next month, another healthy chunk of balance is retired. Further
accelerating payments is also well-rewarded, as eliminating debt
amounts to a guaranteed rate of return.
The current state of rates presents other opportunities
for debt reduction. With yields on many cash and short-term securities
also the lowest in seven years, the incentive to save is lacking.
Taking into account taxes and inflation, many savers are earning
a real rate of return close to zero. Those sitting on idle cash
can better deploy these resources through debt repayment. Many consumers
have a sound habit of saving but due to unfamiliarity or outright
risk aversion, accumulate these funds in accounts that pay a low,
risk-free rate of return. The best way to step up that return is
by reducing the debt burden. Ask yourself if there is a reason to
have excess cash sitting around in low-yielding accounts that could
be used to pay down debt.
OK, but what about the more-aggressive investors?
They aren't sitting on a pile of cash, but they're cringing as their
stock portfolios wilt. Now is a great time for tax-loss selling,
shedding the dead wood in the portfolio and reducing the tax bill.
The sale proceeds can be earmarked for debt reduction, as can any
resulting tax refund in this or future years.
Achieving long-range financial goals can seem like
climbing a mountain, especially in the inevitable trying times such
as these. But doing so while servicing a debt burden is like trying
to climb that mountain with a 50-pound cement block strapped to
your back. Losing that load makes the trek much more manageable,
both now and in the future.
Greg McBride is a financial analyst
for Bankrate.com. For advice regarding your specific situation,
please e-mail one of Bankrate.com's
Q&A experts or visit the Personal Finance Advice channel on Bankrate.com.
-- Updated: July 25, 2002
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