Handling debt wisely is one of the most important parts of your financial life. Borrowing responsibly to attend college, purchase a home, or start a business, can be the ticket to growing your net worth and income for life. But taking too much debt or not understanding the consequences if you can't repay can cause a heap of stress and heartache.
In this post, I'll answer 6 questions that I recently received about student loans, HELOCs, and credit card debt. You'll learn tips to protect your credit, use existing home equity, manage student loan repayment, and prioritize your personal finances.
6 Questions & Answers About Debt
Here are some great questions from Money Girl readers, podcast listeners, and members of Laura's free Dominate Your Dollars Facebook group:
Debt Question #1
Alyssa U. says, “I’ve been listening to your show for a few months now and it’s really inspired me to be proactive with my finances. I improved my credit after it took a hit during an unpaid internship and now I want to help my boyfriend do the same. A friend suggested that I open a credit card with a low limit and add him as an authorized user—would that help him?”
Answer:
Thanks for your question, Alyssa. You sound very considerate, but I’m going to caution you against adding anyone as an authorized user to your credit card. Even with a low credit limit, you could get stuck with way more debt than you’d like if your boyfriend doesn’t handle the card responsibly.
Authorized card users have no legal responsibility to repay debt, even for their own charges. The burden of repaying all debt falls completely on the card owner.
Instead, your boyfriend can easily build his own credit by opening a secured credit card. Secured cards work just like regular ones, except for having to put up a refundable security deposit, which becomes your credit limit. The card issuer holds the deposit as collateral until you close the account and pay your balance in full—or prove your credit-worthiness and transition to one of the company’s regular, unsecured cards.
The minimum required security deposit varies depending on the card you choose, but could be as little as $50. You may also be able to pay a larger deposit in installments over time, such as 60 or 90 days, before your secured card is issued.
The trick to using a secured credit card to build credit is making sure that the issuer reports payment data to one or more of the three nationwide credit bureaus (Experian, Equifax, and TransUnion). Don’t spin your wheels with a card that doesn’t. A history of making on time payments—even if they’re just minimum payments—helps build credit quickly.
The trick to using a secured credit card to build credit is making sure that the issuer reports payment data to one or more of the three nationwide credit bureaus. Don’t spin your wheels with a card that doesn’t.
See also: How to Build Credit with a Secured Credit Card
Debt Question #2
Rick F. says, “My father is looking for ways to help me purchase my first home without handing over a large amount of cash. He owns his home and has a lot of equity in it. After listening to Money Girl episode #496 on getting a HELOC, I’m wondering if it would be okay for him to use a HELOC to help me with my down payment?”
Answer:
The ideal use for a HELOC, or home equity line of credit, is to make home improvements that increase the value of your property. However, a homeowner with equity can use a HELOC for any purpose, even giving it away.
See also: Expert Advice on Getting a Home Equity Line of Credit (HELOC)
Debt Question #3
Sybil P. says, “I got a large tax bill for 2016 and have cash to pay it. But someone suggested that I take out a home equity loan instead so I can write off the interest next year. If my house is paid off, is this a good idea?”
Answer:
As mentioned in the previous answer, you can spend the proceeds from a home equity loan or a HELOC any way you like, including your taxes. And as you mentioned, tapping your home equity comes with a tax break, which reduces the after-tax interest rate you pay.
When you spend a home equity loan or HELOC on home repairs or improvements, you can deduct the interest on a loan amount up to $1 million. But when you spend the funds on anything unrelated to your home, such as income taxes, a gift, or debt consolidation, you can deduct interest on a loan amount up to $100,000.
When you spend a home equity loan or HELOC on home repairs or improvements, you can deduct the interest on a loan amount up to $1 million.
If you have a healthy emergency fund, I’d consider paying some or all your taxes in cash. However, if doing so would leave you with too little cash, then borrowing against your home’s equity is a wise move. Just be sure to take as little as possible because if you can’t pay it back, you risk foreclosure on your home.
See also: 5 Ways to Pay a Tax Bill You Can't Afford
Debt Question #4
Joe P. from San Antonio says, “I enjoyed hearing the podcast about getting a HELOC. Could I use one to pay off a mortgage more quickly? And if so, how does it compare with just sending an extra payment to your mortgage every month?”
Answer:
Getting a second loan on your home to pay off the first one generally isn’t a good idea unless you have a wise strategy. For instance, if your goal is to pay down the first mortgage to a 78% loan-to-value ratio so you can get rid of private mortgage insurance (PMI), that makes sense.
Or perhaps you get a much lower interest rate for a HELOC than you’re currently paying on your first mortgage. However, if interest rates have dropped significantly, refinancing your first mortgage is probably a smarter move. Discuss your options with lenders and compare several offers.
If you want to pay off your home loan more quickly, I recommend making extra payments to your existing mortgage, instead of taking out more debt. However, paying off your home should be your last financial priority because it’s a relatively inexpensive debt and the interest you pay each year may be tax deductible.
If you have extra money to pay down debt ahead of schedule, first make sure you have a strong financial foundation in place. Everyone should have an emergency fund equal to at least 3 to 6 months’ worth of living expenses in an FDIC-insured bank savings account. You should also be preparing for the future by investing a minimum of 10% to 15% of your monthly income in a retirement or brokerage account.
If you have extra money to pay down debt ahead of schedule, first make sure you have a strong financial foundation in place.
Once those priorities are on autopilot, you’re in a good position to begin paying off debt ahead of schedule in order of highest to lowest interest rate. That typically means paying off payday loans, credit cards, and car loans first. Then tackling low-rate debt, such as student loans, mortgages, and HELOCs, last.
See also: Avoid Private Mortgage Insurance (PMI) on Your Home Loan
Debt Question #5
Polly says, “I love the helpful info you provide on your podcast and website. I still owe over $180,000 in student loans after graduating from pharmacy school 7 years ago. I was excited to hear Donald Trump’s campaign promise to forgive student loan debt after 15 years, since that would only leave me with 8 more years of payments. But nothing has been mentioned about it yet. Should I still work aggressively to pay down my student loans?”
Answer:
Thanks for your question, Polly! Right now, if your student loan payments are high compared to your income, you can enroll in a repayment plan that cuts your payments. With some of these plans, your outstanding loan balance can be forgiven after you make payments on time for 20 years.
However, forgiven debt is taxable, so depending on your effective tax rate, you could still owe a fourth or fifth to the federal and state governments. Also, remember that student loan debt is generally only forgiven when you have a financial hardship and can demonstrate that you don’t earn enough to make payments.
The Trump administration has given no details about what they meant by this campaign promise, but it’s likely that taxation on forgiven debt would continue even if the forgiveness period is cut from 20 to 15 years. So, my advice is to always make your student loan payments on time. But I don’t recommend paying them off ahead of schedule unless you have a healthy emergency fund and are regularly investing at least 10% of your income for retirement.
See also: A Blueprint to Prioritize Your Personal Finances
Debt Question #6
Michelle B. says, “I took out a Parent Plus student loan for my son’s college with the understanding that he would pay it back after school. He graduated and is making payments, but it’s a lot for him. I’m on a fixed income and can’t help much. What are the options to make this and another student loan more manageable?
Answer:
Any time you have trouble making student loan payments, call your loan servicing company immediately. For federal loans, there are several income-based options that can lower your monthly payment.
But if you wait until you or your son get behind and miss payments, you’ll have less flexibility because those options may no longer be available once you default. Since you’re the parent borrower on a PLUS loan, you’re completely responsible for repaying the loan. So, act quickly by reaching out and to your lender about your financial situation so they can help you make the loans as manageable as possible.
See also: The 8 Cheapest Ways to Pay Off Your Student Loans
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