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Fundranker Blog—Smart Debt

Smart Debt

Sounds like an oxymoron, doesn’t it? We all know some really good examples of dumb debt, such as high-interest credit card debt, high-interest car loans, and high-interest home equity loans. The common denominator of dumb debt is high interest rates. So smart debt has to be just the opposite--low interest rate loans.

Did you and your parents save up some money for your college expenses? Good for you. You still may qualify for low or no interest (at least while you are in school) loans to pay college expenses. Invest the money you and your parents saved where it can make a better return than the interest you pay on your college loans, which is pretty easy if you don't pay interest while you are in school. If your student loan interest rate resets higher when you graduate, be sure to rethink your situation.

Have you taken advantage of today’s low mortgage rates? Don't be in a hurry to pay off that loan. If you have extra money, don’t make extra principal payments. Instead, invest that extra money where it can make a better return than the interest you pay on your loan. Another bonus of drawing out your low-interest mortgage loan to the last drop is that you get to deduct the interest on your income taxes.

So how can you invest your extra money to make a better return than the interest you pay on your low-interest, smart debt loans? One great, sure-fire, easy idea is to pay down a high-interest, dumb debt loan. The difference in interest rates ends up in your pocket. If you are not averse to more risk and more effort, buy stocks or mutual funds. You could use your extra money for education to prepare yourself for a better job. Put it in a Roth IRA, where it will grow tax free for as long as you have it there and even when you take it out. Any kind of investment will do; it just needs a realistic, potential return that is greater than the cost of your low-interest, smart debt loan.

Here’s an incredible, probably once-in-a-lifetime, smart debt deal of which I took full advantage. We all complain about credit card offers that keep showing up in our mailboxes, but in mid-2006, I received an offer from Discover which included the option to transfer a balance and pay 0% interest on the transferred balance until it was paid off--that’s right, no time limit. The only catch was to make two purchases per month. Since the minimum monthly payments I make go first toward the transferred balance, the purchases have mounted up, and I do have to pay interest on them. I finesse this by making minimal purchases of a few cents at the self-checkout counter in the grocery store or at the gas pump. Two and a half years later, I’m still paying Discover’s minimum finance charge of $0.50 per month on my purchases balance and 0% interest on my remaining transferred balances. My wife and I and my adult daughter applied for three separate Discover accounts with this deal, and we transferred the entire balances of two second mortgages to the three accounts, about $25,000 total. So we have to make six minimal transactions each month (two each on three cards), but for that minimal effort, we have saved thousands of dollars in interest we would have paid on the second mortgages.

Posted 1/21/09 10:18pm ET in Investing