LIBOR and repaying debt with savings

Dear Dr. Don,
What is the LIBOR rate based on and how can I find out what the current LIBOR rate is? -- Sterling Character

Dear Sterling,
LIBOR is the London Interbank Offered Rate. It's similar to our fed funds rate, in that it represents the rate at which banks are willing to loan each other reserves. Unlike fed funds, which represents the rate on an overnight loan between banks, LIBOR is quoted for specific maturities.

A lot of floating-rate debt is priced off the LIBOR yield curve. It's an international standard for interest rates, often used in the United States as an index used to reset the rates of adjustable rate loans. LIBOR is quoted as one-month, three-month, six-month and one-year rates. Bankrate.com's Rate Watch section charts three-month, six-month and one-year LIBOR rates, updated each week. The LIBOR rates, plus other economic statistics, are also included on the Economic Statistics page.

Dear Dr. Don,
Does it make sense to wipe out your savings to pay off credit card debt that never seems to go away, or is it better to pay off the debt slowly and continue earning interest in mutual funds? I've got about 35 more years until retirement.-- Play or Pay

Dear Pay,
If you're asking me if you should use your passbook savings account to pay off your credit cards, the answer is an easy yes. The average savings account yields less than 2 percent while the average credit card costs about 15 percent. Borrowing from your 401(k) to pay off the cards is a different question.

Tax -deferred retirement savings shouldn't be touched unless absolutely necessary. For example, let's say you took $10,000 out of your 401(k) at the beginning of 1999. That withdrawal would reduce the money you have invested and would put you on a repayment schedule, paying yourself a return of, let's say, 8 percent for five years. That would give you a loan payment of roughly $203 per month. At the end of the five years you will have paid your fund $12,180 with $2,180 of that as interest.

The 401(k) loan is costing you 8 percent to pay down your credit card debt, but you also have to consider the opportunity cost of what that money would have been earning if it were invested. The Standard & Poor's 500 should finish the year with a gain of about 18 percent. That 10 percent difference is at least $1,000 that won't be compounded during the next 35 years tax-deferred. You've just diminished your retirement portfolio by about $53,000 (Assuming 12 percent annual returns on the $1,000 during the next 35 years) -- and that's just the hit from the first year of the loan.

A reader told me his 401(k) plan allowed him to stay invested while borrowing against his investment. That type of arrangement would be similar to a margined brokerage account. That is not typical of 401(k) plans but does suggest that you should check with your plan provider to discuss loan provisions before you make your decision.