Give Yourself Greatest Gift: Become Debt Free

Published Sunday, November 18, 2012 at: 7:00 AM EST

If you are nearing retirement, the greatest gift you can give yourself is to become debt free. When you don’t owe anything on your credit cards or a mortgage, there’s no interest to pay and no monthly payments to drain away dollars that you’d much rather spend on things you really need or want. You’ll be amazed at how much extra money this will put at your disposal.

But unless you win the lottery or get a big inheritance, becoming debt free requires careful financial planning, sound investment choices, determination, commitment—and, in most cases, several years to get the job done.

Where do you start? Begin by taking a look at the Big Three:

1. Credit card debt
2. Car payments
3. Home mortgage

Get rid of your plastic debt first. Credit cards tend to carry high interest rates, and using a card to pay for everything from groceries to online purchases can build up a large account balance almost before you know it. Paying down that debt probably will require a systematic plan—for example, budgeting for a particular monthly payment and making it religiously until your balance hits zero. But it also will help if you at least temporarily stop using your credit cards. You can start paying with plastic again once you’ve reached your goal, but even then, make sure you’re able to pay all that you owe each month. Many accounts don’t charge interest if you pay the full balance, and you’ll avoid rebuilding the debt that you’ve worked so hard to eliminate.

Next, turn to your car loans. You may not be paying as high an interest rate on these as on your credit card accounts, but the monthly payments still can be substantial. If you adjusted your budget to free up extra money to retire credit card balances, you could now use that cash to accelerate paying off your vehicle loans. Keep your cars as long as the upkeep costs don’t become prohibitive, and then consider using savings rather than another loan to buy replacements.

Once vehicle debt is eliminated, you’re ready to tackle the big one: your monthly home mortgage payments. Expert opinions differ about whether it’s wise to pay off a mortgage as quickly as possible. If inflation rises at a rapid pace, for example, it may be better to keep the mortgage, because you’ll make future payments with dollars that have lost some of their value. Also, interest rates on home loans are extremely low now, and you could lock in a rock-bottom rate that will reduce your long-term interest expenses. But if you’re planning to stay in your home indefinitely and you like the idea of a debt-free retirement, you could refinance for a shorter loan term or make extra principal payments to pay off the house more quickly.

If you don’t plan to stay in your current home, the expense of refinancing may not be warranted, and depending on how much equity you’ve built up, you may be able to eliminate your mortgage by downsizing to a less expensive home. Moving away from an area with high housing costs could make a big difference, and you might realize enough on the sale of your current home to retire the mortgage and pay cash for your next property. And though depressed values in many areas mean you may not get top dollar for your current home, you’ll likely pay less for the new one than you would during boom times for real estate.

If you take this approach, and if you’ve lived in your home for quite a while, it could make sense to make targeted renovations to prepare for a sale. You’ll almost certainly want to do some exterior and interior painting and make other cosmetic improvements that will show off the house to its best advantage. Undertaking larger improvements—putting in a new kitchen or bathrooms, for example—may be less likely to pay off immediately, though that can depend on your local market.

In any case, you’ll need to choose your contractors and designers with great care. That’s especially true in retirement-heavy states such as Florida, Texas, Arizona, Nevada, and California, where homeowners sometimes have had to contend with fly-by-night outfits that do substandard work or leave projects undone.

To avoid problems, get multiple estimates for the work you’re doing and interview each candidate carefully. Talk with other homeowners who’ve used the contractors’ services and take a look at the finished projects if you can. All of this takes time, but it will be well worth it if you find someone who does good work at a competitive price.

Eliminating all of your debt could take several years, so the sooner you get started, the more likely you’ll achieve your goal before you retire. Good luck!

This article was written by a professional financial journalist for Phase 3 Advisory Services, Ltd and is not intended as legal or investment advice.

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