What Debt Should I Pay Down First?

I fully believe in contributing into your 401k at a minimum of your employer match, though ideally making the maximum contribution. That being said, there are many people that prefer using excess cash to pay down debt.  If you hold credit card debt then this needs to be your number one priority when figuring out how to allocate extra funds.  The average interest rate for a credit card is currently 16.82%, and paying interest at a rate this high won’t help you achieve you’re financial goals anytime soon. Additionally, excess credit card debt can also negatively affect your credit report and score.  But I find many of my friends asking my opinion on whether they should allocate more cash towards paying down their mortgage, or if they should concentrate on paying down their student loans.  You will hear different advice depending on who you talk to, so all I can do is offer my humble opinion.

I currently have a 6.8% rate attached to my student loans.  This rate is fixed so I never have to worry about it going higher, unfortunately it will also never go lower. Student loan interest is tax deductible, however, your modified adjusted gross income needs be less than $70,000 ($145,000 if married and filing jointly). In my case, I haven’t been able to deduct this interest the last three years. 

Last year I purchased my first home, the time was right as I’m marriage is in my near future, I was able to qualify for the $8,000 home tax credit, and rates were very low.  I secured my mortgage at a 30 year fixed rate of 5%.  The benefit of mortgage interest is that it’s pretty much tax deductible for just about anyone as long as it’s their primary residence.   I paid roughly $11,000 in interest in 2010, which is well over the $5,800 standard deduction that a single filer who does not itemize would be allowed.

Considering these facts, I feel it benefits me to use extra cash to pay down my student loans before my mortgage.  I often see articles and unsolicited advice on many blogs that explain the benefits of applying extra payments towards your mortgage.  However, I rarely see anyone explain the downside of lingering student loans.  More and more students are taking out loans to finance their education.  With the income limitation in deducting this interest, and the exceptionally lower mortgage rates that are being offered, I’m surprised that I don’t hear more about paying extra towards student loans first.

Obviously everyone is different, and you need to consider your own personal financial situation.  Though I’m willing to bet that the trend is moving toward people having increasingly higher student loan debt, coupled with rates that are higher than that of their mortgage.

Related article:

• Which debt should I pay off first? (Think Money)