Consumers struggle between paying off installment debt and revolving debt

03.12.09
By John Ulzheimer

“I'm scared I might lose my job. Should I pay off my mortgage from my 401K? Should I pay off my auto loan? What should I pay off?” This series of questions is all too common these days, and it reminds me of something that Certified Financial Planner Bill Losey from Bill Losey Retirement Solutions has told me in the past: “People are motivated by fear and greed.” It seems that the consumer who peppered me with the above questions is being motivated by fear.

The dilemma she is struggling with seems to be what might happen if she loses her income and therefore her ability to continue making payments on her loans. First things first: I’m not sure it’s ever a good idea to tap into your 401K. There are simply too many reasons to avoid doing so, notwithstanding the tax penalties you’ll pay if you don’t pay it back.  

From a credit-scoring perspective, none of the debts she lists above are what we in the financial world refer to as “high risk debt.” An asset, and an important asset at that, secures installment debt, which helps make it low-risk debt. The reason? If you stop making payments on a car loan or a mortgage, it’s just a matter of time before someone of authority takes it back from you. No, the debt to focus on right now is the credit card debt. That’s the high-risk debt that you have to pay off now.

Credit card debt has long been the type of debt that can wreak havoc on someone’s credit scores. It fluctuates from month to month, wildly in some cases. The terms of your credit card accounts can change periodically, and not always in your favor. So if you have steady income coming in and you can afford to pay off one of your debts, paying off the credit card debt is the best thing you can do for your long-term financial health.

But if the income stops coming in and you have to decide what to pay – the mortgage or the credit card bill – something tells me you’d rather keep a roof over your head, even if that means forgoing the credit card payments and your credit scores.

So when it comes to making a choice between roof, wheels, and credit cards, it’s the credit cards that should come in last place. But when you have the ability to pay them, you should. And if you have the ability to throw extra money at credit card debt each month, it’s wise to do so. The goal is for you to get to a point where you don’t care about the interest rates on your credit cards. Why not? If you never revolve a balance, interest rates are irrelevant.  

More Experts Articles | News Home | Discuss in our Forum

Credit card debt can wreak havoc on credit scores.