“Dear Steve,
No car payments, less than $8,000 in credit card debt and only one mortgage (at 6.5% interest rate). I will be receiving a lump sum of money at the end of July or first part of August in the sum of over $75,000. First car runs great and is 2009 model, second car is a 2000 model and starting to have engine repair issues. I’ve been trying to decide the best way to use some of this money.
Which would be your best advice? Pay off all of the credit cards and use some of the money to purchase a better running car with placing the remaining sum in savings? Pay off the credit cards and shop around for a better interest rate on the mortgage? Maybe all three, pay off cards, get newer vehicle, try for a lower interest rate on mortgage?
I get confused with so many people telling me that if you pay off all your credit card debt that it will make your credit score drop but my way of thinking is that I’m current with my mortgage payments and doesn’t that weigh heavier with the credit reporting agencies?
Either way I’m paying the cards off because that will provide an extra $500.00 income per month, which I can put towards the principal on my home. Is this line of thinking better? I’m getting myself confused just typing this, lol. I would greatly appreciate your advice. Thank you!!!!!!
Marie”
Dear Marie,
Thank you for writing me and asking for help.
The first consideration should be if the $75,000 is going to be taxable and you will need to set aside some of the funds to pay for taxes. If so, take that right off the top and put it someplace where you won’t touch it so you have it available for tax time.
Paying off the credit cards won’t hurt your credit score. It’s closing the cards that will. I would suggest you leave open your three oldest major credit cards (Visa, MasterCard, American Express, Discover) and close any store cards or newer major cards. Three cards is a manageable number to keep track of.
Your mortgage rate is not horrible. Depending on how long you plan to stay in the house it might not even make sense to refinance if you are going to have to pay closing costs and points on the new loan. I’d check with a local mortgage broker and do the math to see how long you’d have to remain in your home even at a lower mortgage interest rate to break even.
It’s not clear from your question if you are in a relationship or just have two cars for yourself. If it’s just for you, sell the older car. But if the issue is you need to deal with repairs on the older car and except for some mechanical issues it is in good shape, then it might just make more mathematical sense to get the older car repaired and maybe even the engine replaced or overhauled rather than buying a new car. A well maintained vehicle can last for many years and if it’s just secondary or basic transportation for someone to get back and forth on a short commute then replacing it might not be a smart move.
I like what I call Steve’s Law of Thirds when it comes to financial windfalls. My opinion is that you should first set aside any taxes due, payoff any priority debts (credit cards) and with the remaining money you could put 1/3 in savings, put 1/3 in your retirement account, and just go and blow 1/3 and do something just for yourself.
My biggest concern these days is people saving for retirement. Almost half of workers surveyed say they won’t be able to save enough to retire comfortably. This windfall is a blessed opportunity to help bolster your retirement savings and let it grow.
But I also think it’s important to enjoy money when you can and do something just for yourself.
Let me know what you eventually decide to do.
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Steve,
You forgot to mention a no-cost refinance, or even better asking her lender to recast her loan. Depending on what her credit score is, PenFed is a bank that comes to mind for a no-cost refi.
Typically, if you pay down a large sum of money on your mortgage, the lender can basically redo the payments over your remaining term, at the new sum. Hence, re-cast.
Maybe PenFed has a true no cost product. I have not looked at it but the “no cost” refinance products I have looked at have rolled the fees up into the loan. Forbes had a good piece on this last year. http://www.forbes.com/sites/moneybuilder/2012/03/28/the-no-cost-refinancing-myth/
But that’s why I suggested a local mortgage broker and doing the math to look and see what products made sense.
Thanks for the comment.