Money for nothing

December 15, 2007 11:46 PM

I owe about $40K and just inherited $20K. Invest or pay down debt?

I realize many variations of this question have been posted before; I hope this is sufficiently unique.

I'm in Canada and 35 years old. Married a few years ago. The wife has had bad luck with employment and neither of us are great with money management. I seem to be just good enough with money to make creditors love me.

We've (I've) amassed a $40k debt in about five years. Two credit cards at 20% interest and a line of credit at 9%.

Recently Mrs. Raider rebounded from a layoff by getting a good and stable new job, making around 42k. I make about the same in a stable job with a company car.

So we're in a position to attack the spiralling, suffocating debt. But doing so against huge interest would be a looooong battle. I have looked into credit relief companies and the numbers are enticing but the downside is a credit rating of "fuck you"

I requested my credit rating from two companies and it is pristine right now.

So...

1. I would love to consolidate debts at a lower interest rate but that was my reason for getting the line of credit at the bank years ago. While I believe a 20k increase would be mutually beneficial, I understand that such a request might be rejected and any rejected credit request leaves a nasty scar. So I'm paranoid about asking for credit in case it affects my credit.

2. I just got a Christmas card with a cheque for $20k. An early inheritance.

I do have an active RRSP (worth about 10k five years ago... for all I know it could be worthless now or maybe I'm rich)


So, what to do? Logic seems to dictate I throw the money at debt. But maybe with discipline it could be invested and we deal with the debts responsibly.


I'm sure I'm not the first to have faced this situation. Advice?

posted by raider to work & money (42 comments total)

Two credit cards at 20% interest

That's a guaranteed 20% return on your money if you invest in paying down your debt.

Maybe buy one cool thing for a thousand bucks to feed the beast, but I can't see any reason not to put the majority towards your debts.
posted by IvyMike at 11:57 PM on December 15, 2007

I am thinking that you will never find a guaranteed rate of return on $20k that will be greater than the interest you are paying on $40k debt, not even close. Therefore every month you will be paying out more than you are making on the investment.

Paying down $20k will save you thousands in interest over the life of the debt, but someone better with the math will probably be able to back this up with numbers.
posted by clarkie666 at 12:00 AM on December 16, 2007

Throw most of it at the debt, use the rest to invest. Unless you think you can earn an insane rate of return on your investments, you'll be saving money in the long run by paying down the debt, but if you set some of it aside, you'll at least feel like your inheritance didn't just get tossed into a void.

Talk to you banks about the debt, too. There are more options than just consolidation. My girlfriend went to our credit union in a similar situation. Her initial plan was to take out a personal loan to pay off some of her credit cards, but as it turned out, she was able to simply get an increase on her credit card from the union at an even lower interest rate, then transfer the balance of her other credit cards over to that particular card. It didn't give her a nasty mark on her credit report, but it is saving her a lot of money in interest as she pays off the debt over time.

Last but not least, if you don't have an emergency fund set up, it might be smart to set one up in a high-interest online savings account or somewhere similar.
posted by infinitywaltz at 12:02 AM on December 16, 2007

Can you clarify how this debt is distributed? Possibly, if the credit card debt at 20% is only a small fraction of the $40K, it might be worthwhile leaving some of the 9% debt alone and putting some of your $20K in an investment. Maybe. Possibly.

But no one, no one should have debt at 20%.

If you just paid the interest, you would have to pay $8000 per year to feed $40K at 20%. But worse, you'd actually have to make more than that, because you pay out of your after-tax income. If you paid off $20K with your "early inheritance", not only would you halve your debt, you would save potentially $4K annually in interest alone.

Any investment that returns 20% has a component of risk, possibly quite a lot of risk. Paying debt is absolutely certain. Your greatest return on the money will always be to pay down your debt, starting with the highest interest debt.

It may be psychologically rewarding to buy a little something nice, spending maybe $1K, just so you feel you have something concrete to show for it. But otherwise, pay your debt. AND DON'T INCUR ANY MORE. If I were a beneficent relative, I would not be paying the younguns' credit card bills a second time, if they couldn't show enough sense to keep out of trouble.
posted by i_am_joe's_spleen at 12:24 AM on December 16, 2007

"Unless you think you can earn an insane rate of return on your investments, you'll be saving money in the long run by paying down the debt"


Of course you're right (though I have considered getting into pimping)

What I failed to express in my question is the emotional cost of watching this money "disappear" vs. watching it "grow"


It's not just any money, it's Granny Money. And dead Grampa money, and his wisdom and frugality are the reasons I have this cheque. Guilt is a factor here.
posted by raider at 12:27 AM on December 16, 2007

PS:

Suppose you owe 40K at 20%. Suppose you can afford to pay $1000 per month. It will take you 5 years and 7 months to pay. Your total interest paid would be a horrendous 25,415.93

If you only owed $20K, because of the way compound interest works, you would be debt free in far less than half the time - it would only take 2 years and 1 month. And the interest paid would be a much much lower figure: $4,462.62. So you have gain many months of freedom but most importantly over 20 grand interest payments, by paying down $20K right now.

Have a play with the calculators here and plug your own numbers in.
posted by i_am_joe's_spleen at 12:31 AM on December 16, 2007 [5 favorites has favorites]

Why not think of the 20k check as a replacement for the 20k increase in your line of credit? Pay off anything you would have paid with that increase. (I assume from your question that you have about 20k in the line-of-credit and 20k on credit cards, so you could pay the cards basically off with this, and then you've just got the LOC to do).
posted by jacalata at 12:31 AM on December 16, 2007

"wisdom and frugality"

No wise or frugal person would do anything with this money other than get out of debt. Don't annoy your elders by wasting this chance.
posted by i_am_joe's_spleen at 12:32 AM on December 16, 2007 [1 favorite has favorites]

On non-preview: would it help if you committed to actually saving the money that you're not putting towards the paid debt? Say you get to avoid $8000 in interest payments this year. Don't just add the money to your 'available' pile: it's now allocated strictly to your 'saving like Gramps' fund. If you can afford to, do this with the entire payments you would have been making, not just the interest, so that you just pretend that you haven't paid off anything. The bonus of this is that you, not the credit card company, get to keep the huge interest payment on your 20k, so you would be making the absolute most of the opportunity your Grandpa has given you.
posted by jacalata at 12:38 AM on December 16, 2007 [4 favorites has favorites]

but the downside is a credit rating of "fuck you"

So? By your own admission you need to be less dependent on credit. Look where it's gotten you. Consolidate at a lower interest rate with a decent lender. Put that 20k toward the debt and don't look back.
posted by tarheelcoxn at 12:38 AM on December 16, 2007

Thanks for the replies so far.

The line of credit is approx 19000. Credit cards are about 22000 combined.


And there will be no toys bought. Okay, maybe a dildo. But it's not for me.
posted by raider at 12:41 AM on December 16, 2007

One more vote for paying the debt.

What I failed to express in my question is the emotional cost of watching this money "disappear" vs. watching it "grow"... his wisdom and frugality are the reasons I have this cheque. Guilt is a factor here.

With all due respect, this shouldn't be an emotional question. If you want to be a wise and frugal person, you pay the debt. Don't feel guilty, it's the right thing to do.
posted by blue mustard at 12:57 AM on December 16, 2007

i_am_joe's_spleen link is pure solid gold. The loan repayment tool lays it out so clear: use the money to pay down the debt.
posted by letitrain at 1:12 AM on December 16, 2007

Another vote for paying off the debt, plus I'd say you should leverage the guilt to set money aside till you've paid off the rest and saved 20k.
posted by XMLicious at 2:18 AM on December 16, 2007

I like jacalata's idea of taking the money you would have put on the cards and saving it to feel less guilty and more like "Gramps"...

Re. the issue of psychology, would it help if you considered the debt you've incurred as having been money borrowed in advance for some purchases? I'd hope you have something to show for the debt, so you can say "Well, I borrowed the money x years ago to get a nice TV, which served me well for x years... Now I have the money, I can pay it off, so I had the advantage of the TV for all that time and if I really think about it, the $20k bought me the new TV (x years ago)!"
posted by ranglin at 2:29 AM on December 16, 2007

Try to consolidate your debt into a lower or no interest rate, 20% interest is outrageous. You say you have good credit, you should be able to do this. Then cut up your credit cards. It isn't easy and if you're nervous and feel that you need to save one for emergencies, put it in a ziplock bag and then in a large container of water in the freezer, that way if you need to use it, you have time to think about it first while the ice thaws.

Even though your interest is currently 20% and this is likely to be more than you'd earn from any investment, I can understand wanting to see the money grow. Perhaps you could take a small amount, like $1000, and put it into an investment or high yielding savings account of some sort. It's a good idea to have something like this for an emergency fund anyway. While you should be throwing as much disposable income as you can afford at the debt, you could also set up a direct debit from your bank account on the day you get paid, to add a small amount to this investment/savings account - even if it's only $25. You'll get the satisfaction of seeing this grow over time.

You should really look at all the things they have to say about paying off debt at Get Rich Slowly, especially the Debt Snowball. Make sure to click on all the links about debt. It's a treasure trove of information. Good luck.
posted by triggerfinger at 2:34 AM on December 16, 2007

And don't get into debt again
posted by A189Nut at 2:43 AM on December 16, 2007

Any frugal old timer would be horrified you owe so much on lifestyle debt. They would be delighted if you paid it down and then kept up the level of your current payments to more quickly wipe out the remainder.
I'm not credit averse, I have a big mortgage, but I pay off my card in full each month. Up till now you have struggled with the discipline needed to make an investment work, so look at this very fortunate gift as a get-out-of-jail card to do the right financial thing and halve your debt.
If you *really* have an emotional attachment to showing something for the money, pay off the debt and redirect the freed up payments to an investment that allows, or preferably demands, regular deposits.
There are mutual funds that you can set a fixed investment each month.
All that said, where will you invest this? It sounds like you aren't a financial high flyer, and by any measure the stock market looks high, and property is no bargain.
One of the biggest problems people with no debt and lots of money face is finding a safe place to invest and grow their money. You already have this, by paying down your most expensive loans.
As an aside, I really, really, would do some thing about your interest levels. They are extortionate unless you are a deadbeat. Pay off the cards and re-fi the line of credit to a lower rate personal loan. Those cards cost you $4400 a year you could invest if you got rid of them.
Let us know how you go.
posted by bystander at 3:49 AM on December 16, 2007

Guilt is a factor here

then give the money to a deserving charity.

or, use the 20K to pay off half the debt and get a night job to pay off the rest of the debt.

also, 20% is loan sharking, I'm sure it'd be illegal in many countries
posted by matteo at 3:59 AM on December 16, 2007

Your Granny would definitely want you to pay down the debt. Buy yourself a nice frame for your favorite picture of her and spend the rest on the debt.
posted by ubiquity at 4:56 AM on December 16, 2007

It's not just any money, it's Granny Money. And dead Grampa money, and his wisdom and frugality are the reasons I have this cheque. Guilt is a factor here.

If dead Grampa were alive today, and you asked him what to do with the money, you can be damned sure his wisdom and frugality would sound awfully similar to i_am_joes_spleen's comment:

It will take you 5 years and 7 months to pay. Your total interest paid would be a horrendous 25,415.93.

If you only owed $20K, [...] it would only take 2 years and 1 month. And the interest paid would be a much much lower figure: $4,462.62.

There's your answer in white and bold-white. It couldn't be any simpler. If you want to feel less bad about being so fiscally responsible, you can take a grand off the top and pretend like that's all the inheritance you got.
posted by Civil_Disobedient at 4:59 AM on December 16, 2007 [1 favorite has favorites]

There's no question that you should put that entire $20k toward your credit cards immediately. Doing anything else with it while you have that much debt would be foolish. The money isn't disappearing, it's helping you get your net worth out of the hole. Then pay off your new low low credit card balance of $2k as aggressively as you can. Then do the same with your line of credit --with your credit cards paid off, you'll have plenty of extra money each month. Put all of that money you were paying on the credit cards toward your line of credit. It's called the snowball method and it really works.
posted by boomchicka at 6:15 AM on December 16, 2007

Another vote for paying down debt, though I would pick up a shiny thing of some sort.
posted by craven_morhead at 7:02 AM on December 16, 2007

I agree. Pay off the debt.
posted by thetenthstory at 7:02 AM on December 16, 2007

Unless you can find investments that you can guarantee would have a higher return than what you are paying interest-wise on your credit card, pay the debt off first. Trying to find anything to invest in that will make 20% or more is too risky and probably will not give you the results you want.
posted by toaster at 7:12 AM on December 16, 2007

You have to know how fucking GREAT it is going to feel to pay off that credit card.

It won't be like throwing money down a hole.

It will be one of the best feelings you've had in a long time.

Much better than opening a shiny new anything that you could buy.

I feel happy every month just dumping $1500 on my student loans. If somebody gave me $20 grand it would be gone in a heartbeat.
posted by davey_darling at 7:18 AM on December 16, 2007

I would go talk to a bank about sticking that $20,000 in a CD and using it as collateral to borrow $40,000 in a personal loan to pay off the credit cards, and since you and your spouse are now working, set up an automatic deduction toward savings through the same bank. Take $100 out of each check automatically and re-route it toward savings. The interest on a personal loan would be a lot less, probably closer to half or less, of the interest rate you are paying on the cards now. Pay them off in one lump sum and cancel those cards and get a card with a decent interest rate. 20% is not decent! In the meantime, call your credit card company and ask them to lower your credit rate to something closer to 13% and threaten to transfer the balance to a different card. They'd rather have 13% than nothing.

A CD typically isn't a great investment, but it is a solid one. You have this "found money" and I think you should act as if you don't have it, but use it to leverage yourself out of debt besides using it directly. Use it as the opportunity it is, which is an opportunity to strengthen your future financial situation while you are also teaching yourself new financial habits. Just throwing that 20 grand at your gaping hole of debt isn't learning new spending patterns and really isn't getting you as far ahead as leveraging that money could.

Good luck, and what a wonderful surprise to get such a nice amount of money. May it be the path to a sounder financial foothold.
posted by 45moore45 at 7:38 AM on December 16, 2007

With all due respect, this shouldn't be an emotional question.

No way. This is within a family, and the giver is still alive. Her expectations matter.
posted by ROU_Xenophobe at 7:43 AM on December 16, 2007

It's not Granny's emotions he seems worried about, it's his. If granny has an opinion, that's relevant, but I bet if she does it's 'Holy Jesus Chris, you're paying 20% interest on anything? And the people holding that debt aren't the type to break knees? Are you insane?'

I think you're significantly overestimating the chances of being declined for a consolidation loan -- as you say, your credit is very good now. And if you go to your bank/credit union and tell them 'this is my income, this is my debt load, this is my credit score, hypothetically speaking is it worth applying?' they will tell you whether you're likely to get the loan or not. It's not iron clad, but it could reduce your nervousness without affecting your credit score. Even if you eventually plan to buy a house, by the time you save up a down payment any effect on your score brought on by having been turned down for a loan (not that that's likely to happen) will have worn off.

What worries me in your scenario is that you have no recourse in the event of another job loss, except more credit card debt at that crippling 20% rate. Use 12-15K to pay down the credit cards (Grandpa will approve). Go, get a consolidation loan, or enhance your line of credit to get all of the remaining debt at a rate down below 20% -- 9% is tolerable. Put the remaining 5-8K (amount equal to at least 3 months monthly expenses) into a high yield savings or a series of short term GICs, depending on which is offering better interest rates, to act as your 'emergency fund'. Don't spend your emergency fund, either, unless it's actually, you know, an emergency.

Then stop using your credit cards. Cut them up if you have to. Whether you should get the credit limit lowered and keep them or leave it the same and keep them or just get rid of them entirely is something you might want to look into. Those things will all have different effects on your credit. It's only a choice if you can *stop* using them, though, otherwise, close the accounts.

Plow all the money you're not spending servicing your debt at 20% into clearing up the stuff that you're now servicing at 9% so you can get that out of the way, then start plowing all that money into a) increasing your emergency fund to 6 months worth of expense b) making regular contributions to your RRSP and c) saving money for other fun or worthwhile larger purchases (house, car, vacation, Christmas gifts, whatever). Doing b) can really help with a) and c) because you get a nice cheque back from the government in April that can immediately be put into either the a) or c) fund.
posted by jacquilynne at 8:38 AM on December 16, 2007

You currently have $22K on your credit cards and a check for $20K. Here's what you do.

1. Buy a decent bottle of champagne.
2. Scrape together another $2K.
3. Pay off your credit cards in full.
4. Have a small party where you destroy those credit cards and toast your excellent fortune with the champagne. It should be cause for celebration.
posted by adamrice at 8:38 AM on December 16, 2007

Pay off the 20% debt and then reduce your lifestyle so you don't reaccumulate any more debt at that interest rate. It is unwise to pay that much interest.
posted by ikkyu2 at 8:45 AM on December 16, 2007

the emotional cost of watching this money "disappear" instead of "grow"

Thing is, it's already disappearing. It's doing it on a monthly basis.

If you try to invest this money instead of paying your debt down, it'll still be disappearing, just a tiny bit slower. Trying to invest this would be like building a sandcastle below low tide; the waves are going to carry the sand away a lot faster than you can pile it up.

I seem to be just good enough with money to make creditors love me.

On the off chance you don't already realize this, what this means is that you are not good with money at all. Creditors love people who get deep into debt; all your interest and late fees are their bread and butter.
posted by ook at 8:58 AM on December 16, 2007

No way. This is within a family, and the giver is still alive. Her expectations matter.

Sure. I'm assuming that the giver expects the recipient to benefit as much as possible from this gift.
posted by blue mustard at 9:38 AM on December 16, 2007

One more observation: you say you've racked up 40K in just 5 years. (How does anyone get credit equal to their annual income with no security? Mindblowing). And you talk about the emotional impact of seeing the money disappear. It seems to me that you have some very bad instincts about money and value, and beyond paying your debt off, you need to re-educate yourself, so that your instincts are aligned with financial reality.

Otherwise, you'll get more cards, you'll extend your line of credit, and this will happen again, and eventually, you and Mrs Raider will be old and penniless and surrounded by junk. Or middleaged and bankrupt in an empty house, watching the repo men cart your goodies away.

You have 25 years left to put aside money on which to retire, and you are starting from worse than zero. If you want to end up as well-off as your grandparents, you need to get started right now, and never look back.

So: set aside $30 from your $40k, and buy a personal finance book. It probably doesn't matter which one, they pretty much all cover the same ground. Join your public library and borrow some more (see, frugal people don't buy books that are in the library). Check out Mefite jdroth's Get Rich Slowly blog. Try to recast credit in your mind as an stupid drug for stupid people.

(This is why I'd personally not recommend 45moore45's advice, although depending on interest rates I can see how it would work. I think you have to walk before you can run. Until you can figure out the numbers yourself and back yourself to stick to your plans, I think you'd best off taking a very simple brainless approach).

FYI, my income is about 50% bigger than yours. I have one (1) card. It is used for regular expenses, paid off in full every month, and the limit is $2K. The only reason I use it is that my bank charges transaction fees on normal accounts, but doesn't on credit card transactions, and my card has an interest free period. So I enjoy the interest from maximising the balance in my bank account and the free transactions from the credit card.

I deliberately got a low limit that I know I can always manage. I have set things up so I can't get into the situation you're in.
posted by i_am_joe's_spleen at 11:14 AM on December 16, 2007

the emotional cost of watching this money "disappear" instead of "grow"

Not to belabor the point, but it might be eye-opening to go through your check register and add up the total amount of money you've spent on this debt, and compare that the the amount by which you've decreased the debt (if at all). It might help put things in perspective.

If you've got $22K at 20%, and do nothing to reduce the principle, you rack up $6,400 in interest in one year. Just holding the principal steady, you'll pay about $20K over three years and still owe $22K.
posted by adamrice at 11:24 AM on December 16, 2007

So? By your own admission you need to be less dependent on credit. Look where it's gotten you. Consolidate at a lower interest rate with a decent lender. Put that 20k toward the debt and don't look back.

A bad credit rating screws you over more than simply not being able to charge HDTVs or get huge loans. It also takes absofuckingloutley forever to correct.
posted by Mikey-San at 12:30 PM on December 16, 2007

Any suggestions not to pay off the credit cards are great for somebody who isn't you.
You have a mountain of debt relative to your income, little or no assets and are paying extremely high interest. If you were even average with financial matters you would long ago have sorted out the high interest problem, and would not have spent so much.
You are not good with money - the evidence is right there to see each month.
You need to learn about a budget, make one and stick to one. You are super lucky that you have an inheritance to help.
You need to understand you threw this money away already when you made the hundreds of decisions that got you so deeply in debt.
Hoping that having $20k to 'invest' (where?) will somehow make you knowledgeable and responsible with money is just a wish.
posted by bystander at 3:06 PM on December 16, 2007

Slight suggestion. As most people say, you want to put a great majority on repaying the debt. But make a very small happy purchase. Nothing huge -- I'm talking like out of your $40k, spending $100 on something you'll like. It helps you maintain discipline when you temper it with a little self-kindness.
posted by WCityMike at 7:47 PM on December 16, 2007

1. Mentally devote yourself to getting out of debt.
2. Scrape together $2000 so you have $22K in capital and $22K in credit card debt.
3. Seek credit cards that have 0% introductory periods (usually of a year) and that charge no balance transfer fees.
4. Move as much as possible of your $22,000 in debt there. Let's say you get two cards with maxes of $8K, for a total of let's say, $16,000.
5. Pay off the rest of the credit card debt (in this case $6,000) with the inheritance+ money.
6. Put the remaining $16,000 of capital somewhere safe, probably a savings account that earns around 5% interest. Now you have $16K of debt at 0% interest and $16K of capital earning 5% interest.
7. Take note that if you are late on one payment, that 0% interest suddenly jumps to something like 12%. So put those cards on auto-pay! You can also get in trouble by using those cards for daily expenses, so don't do that either.
7. Try to pay off as much of that $16K as humanly possible within one year. You can be inspired by the fact that everything you pay off, you get to keep from the inheritance at the end of the year.
8. At the end of the year, pay off whatever remains of that $16K in debt with the inheritance. If you miss payments on your 0% card during the year and suddenly start getting hit with finance charges there, you can also pay it off at that point.

(Yes, I admit that the most financially savvy thing to do is that, at step 6, rather than investing the capital at only 5% interest, pay off your bank loan, effectively earning 9% interest on your money. Before doing that, I'd make sure that they'd be likely to let you transfer over whatever you end up not being able to pay off. Psychologically, though, I think my plan might be better!)
posted by salvia at 9:05 PM on December 16, 2007

Pay off the debt with all of it. Seriously. You don't have any other intelligent option.
posted by dmt at 11:14 AM on December 17, 2007

Whether or not you decide to pay down your debts, and I agree you should, I think the advice offered by infinitywaltz and jacquilynne regarding the "emergency fund" is very important. The theory is that when you don't have an easily-accessible emergency fund, every unforeseen expense (whether a flight to a funeral or repairs to your roof or replacing a busted appliance or all those billion other things that just come up) will force you to get out the credit card again, and you never catch up. Whether your emergency fund needs to be a thousand bucks or six months salary is something reasonable people can disagree on, and probably depends on your lifestyle, job security, whether you own a house, etc. Good luck, how to spend $20,000 is a nice dilemma to have!
posted by jamesonandwater at 11:36 AM on December 17, 2007

Thanks so much everyone. Some responses will have to be re-read and considered but I think the bottom line is obvious. Those who inferred that discipline is key are quite correct.

We have received large gifts before and they've "slipped away". I'm determined to not let this happen again.

Thanks again, Merry Christmas.
posted by raider at 7:33 PM on December 18, 2007