I want to pay off my credit card debt once and for all. Is selling mutual funds the best strategy to do this?

January 3, 2008 12:54 PM

I want to pay off my credit card debt once and for all. Is selling mutual funds the best strategy to do this?

I am coming to terms with my credit card debt. This means calculating my total debt and creating a realistic payment plan that works with my income as well as discontinuing the use of my credit cards and opting to use my debit card for internet purchases instead.

I have three credit cards:
I opened the account for Credit Card 1 in 2001 and have a credit limit of $12,000; I currently owe $5,100 on that card. The interest rate is currently about 7%.

I opened the account for Credit Card 2 in 2006 and have a credit limit of $5,100; I currently owe $3,300 on that card. The interest rate is currently about 12%.

I opened the account for Credit Card 3 in 2007 and have a credit limit of $5,000; I currently owe $4,300 on that card. The interest rate is currently about 13%.

Both Card 2 and Card 3 were balance transfers from Card 1. Both had 0% interest rates initially and the transfers were made in the hopes of paying off the balances while not accruing interest on the amount owed. The problem is that I kept using Card 1.

I have always paid above the minimum on time and have no negative marks on any of my three credit reports. I am not sure what my FICO score currently is, but I do know that of $22,100 in total credit offered to me, I owe $12,700.

With my current income of I can afford to pay approx. $150 each to Cards 1 and 2 and $350 to $450 to Card 3 (in the interest of paying off the card earning the highest interest first) per month. I “give” myself $50 a week in cash to spend on whatever I want but once it is gone, it is gone. I live with my boyfriend and another roommate and we split costs for rent, utilities, apartment needs (toilet paper, etc.), two cats and groceries.

I have money in mutual funds totaling approximately $16,000 currently. It was invested to pay for my college education. I have already earned my BA and am looking to go back for my MA in the fall. I am considering selling the funds to pay off my debt and then reinvesting the money that I would normally pay toward my credit cards as well as setting some aside in a high interest savings account. This could be reapplied to my college education if I need. My conclusion is that financially it is a sounder decision to pay off most or all of my credit card debt now with money that is probably earning a lower interest rate than my cards are charging. I think that paying the interest on the cards over the next couple years would equal literally throwing money away.

I would love to hear thoughts of others who are financially wiser/more experienced than me on this matter! Thank you!

posted by lolalivia to work & money (15 comments total)

I'd sell the funds and pay off the cards, then pay what you've planned to save into a new fund. The risk as I see it is that you have now spent your safety net. In the end you're earning 5-10% on your new investment (small as it will start) rather than building more compound interest debt.

No cash for the MA program means a better financial aid package in any case.
posted by kcm at 12:59 PM on January 3 [1 favorite]

If you decide to sell the mutual funds and pay off the cards, make sure you understand the tax consequences. It might mean you need to have some cash laid aside in a high interest savings account (just as you are planning), for the purposes of paying the taxman.
posted by needled at 1:04 PM on January 3

Unless you expect the mutual funds to yield a return greater than the credit card's interest rates, yes you will increase your future net worth by selling the mutual funds to pay off the card balances.

Note that this does not take any possible tax liabilities into account (owing tax on any gain in the mutual fund's values since you purchased them).

Personally, I'd sell enough mutual funds to pay off #2 and #3 and continue to pay off #1 at the rate of $600/month while investing the rest of your discretionary income.
posted by de void at 1:05 PM on January 3 [1 favorite]

Definitely pay off the cards. Your mutual funds may even lose money in the near term (esp. given the state of the economy), but even a high-performing fund would have to do unreasonably well just to match what you're paying in interest (given fees, taxes).
posted by azure_swing at 1:07 PM on January 3

If you pay off your cards (and you should), make sure you cancel them so you don't get back in this situation again.
posted by grumpy at 1:13 PM on January 3

Even if you don't want to apply the mutual fund money to the credit card balance, it's probably worth selling anyway (depending on the tax situation).

It's a risky time in the market, this year could go way down... because of all the economic turmoil in the markets right now. I'm personally still bullish, but feel that we're hanging on by a thread. It will be very easy for the market to tank this year.

Since you need the money in the fall, you should move it to somewhere you won't lose it.

Figure out what the tax consequence is, and what it would be if the markets fell 20% by the fall, and figure out if you should take the hit now, and move it to a safe place. I pulled the 20% out of thin air, but if things start going really wrong, I could see it happening.
posted by cschneid at 1:23 PM on January 3

No cash for the MA program means a better financial aid package in any case.

Indeed. If you need money for school, most student loans won't charge you interest while you're a student and have an interest rate below any of your credit cards. Might want to have a quick chat with an accountant, but unless the tax consequences of cashing out the mutual funds are truly insane, pay off all those cards now. Then cut them up and don't use them again *ever* until you're learned to properly manage debt. Find other ways to improve your FICO score (once you learn what it actually is).
posted by Nelsormensch at 1:36 PM on January 3

make sure you cancel them so you don't get back in this situation again.

If you're concerned about your credit score, do not arbitrarily cancel your cards.

Closing a line of credit zings your score. Your score is largely determined by the amount owed versus the amount available. Right now you're at a little over 50%. But if you're not careful as you close accounts you can accidentally increase that ratio. Imagine if you only had one card with a $12,000 limit for which you owed $10,000 - in some ways you'd be better off than you are now (overall owing less) but your score would suffer because your line of credit would be almost depleted.

Furthermore for whatever reasons your score is still zinged when you close a card regardless of your debt. So if you're going to close the cards, do one a year after careful planning.

A better method is just to cut the cards up and throw them away without closing the accounts. This reduces the temptation to use them, but allows you the possibility down the road to get the cards back god-forbid you "need" them.

This is just one of the non-intuitive pitfalls of dealing with credit cards and yet one more example of why they are probably inherently evil.
posted by wfrgms at 1:41 PM on January 3 [1 favorite]

IANAFA:

Implications to selling mutual funds:

1) Capital gain taxes. If these were for college, you'll probably be in the long-term capital gain category.

2) Redemption fees. Some "B-Class" and "C-Class" (or others, those are the most common names) mutual funds have redemption fees that kick in if you sell the fund too early. B-Class redemption fees often go for five years or more after the purchase. Check your mutual fund prospectus for details.

If you like your current investments, only sell just enough to pay off the credit cards plus taxes and fees. Otherwise, if you reinvest in the same funds, the capital gains clock and back end fees (if applicable) will start over.

One more note: This is probably obvious, but if you want to redeem your funds in the reverse order that you would pay the cards. For instance, sell the ones that you expect to have the lowest returns first, then the one with the next lowest returns, etc. As always, past performance of your mutual funds is no guarantee of future results.
posted by Pants! at 1:42 PM on January 3 [1 favorite]

Never touch the savings. It's not that much money and who knows what might befall you such that you would need it.

If you want to pay off the cards, cut them up and throw them away so that you can not use them. Keep making your payments. Roll over what you can into zero or no interest cards and cut those cards up when they arrive. you will be all paid off in a few years and you will still have savings. If you tap into your savings to pay them off it is unlikely you will continue to pay yourself like you are paying the cards to reestablish that savings.
posted by caddis at 1:56 PM on January 3

wfrgms is right, but since the OP has twice paid off Card#1 only to run it back up again, I'm guessing that unless she cancels the cards after she pays them off, in a year she'll have exactly as much debit and zero money in mutual funds, which will be even worse from a credit rating standpoint.
posted by grumpy at 2:06 PM on January 3

If you want to pay off the cards for good, do it the hard way and chip away at the CC debt with your income. You need to change your spending habits. I'm going to guess that if you do it the easy way and use your mutual fund money to pay down your CCs you will run up CC debt again in the future. Change your spending habits and get rid of the debt for good.
posted by PFL at 2:17 PM on January 3 [1 favorite]

Look at the potential of your mutual fund investments to grow. Read about compound interest. If it's earning anywhere around than 7-13% annually it would seem not to be worth it, and that's not even considering capital gains taxes.. If you feel you must pay off debt now, why not just sell a portion of your mutual funds and work on paying the rest off using your income? Oh, and read this. (IANAFA, Markets have risk, etc)
posted by entropy at 5:18 PM on January 3

My instinct is to tell you to cash in, and pay off. Assuming minimal fees or penalties, you'll be left with $3000 after paying off the cards, which is a decent emergency fund. At an average of 10%, your cards' balance will charge you around $1200 in a year. Unless your mutual fund is spectacularly lucky, you're not going to be making that much from interest.

If you don't want to, or can't cash out of the mutual funds right now, transfer those 12% and 13% cards immediately either back to the 7% one if possible, or to a brand new 0% introductory card, but be sure to continue paying off the balances as much as possible. Keep the interest rate on your debt as low as possible.

All the same, the consumer market being what it is, paying off credit cards is pretty much always the better idea in the long run, and certainly easier on your nerves. Take the credit cards and put them inside an envelope that you place in a desk drawer, filing cabinet, or safe. It's a lot harder to make frivolous purchases on credit if you have to actually get up and grab your card, and if you don't take it with you to stores.
posted by explosion at 6:44 AM on January 4 [1 favorite]

Thanks, everyone for your input on this. I decided to take out enough to pay off #2 and #3 and will continue paying off #1 with my regular income (holla, de void!). I have also discussed this move with my tax consultant to confirm the income tax implications. Thank you again!!
posted by lolalivia at 10:41 AM on January 4