It may be time to reassess your debt-payoff plan.
Consumers with debt are often juggling multiple types and accounts. At the end of September, the average household with credit card debt carried a balance of $15,654, according to a NerdWallet.com analysis. Those with auto loans owed an average $27,669; student loans, $46,597; and mortgages, $173,995.
The new tax code and rising interest rates could influence which of your various debts it makes sense to focus on repaying faster, especially if you’ve been prioritizing debts from most to least expensive. (See infographic at the end of the story.)
“The calculation could be different, particularly when you’re comparing the costs of varying types of debt,” said Greg McBride, chief financial analyst for Bankrate.com.
Here’s what’s at play:
The Federal Reserve has been slowly increasing the federal funds rate, and is expected to make three more hikes in 2018. Each uptick can directly and indirectly generate rate increases on consumer debt — especially in variable-rate products like credit cards, home equity lines of credit and private student loans.
Then there’s the new tax code, which changes the deductibility of some kinds of debt.
Interest paid on home equity loans and lines of credit is no longer deductible, for example, and there’s a lower cap of $750,000 on qualifying debt for the mortgage interest deduction. (The previous $1 million limit will remain in effect for homes purchased before Dec. 15, 2017.)
“The calculation could be different, particularly when you’re comparing the costs of varying types of debt.”
Experts expect that other elements of the tax bill — including the near-doubling of the standard deduction and the $10,000 cap on property, state and local income taxes — will mean fewer taxpayers itemize. A December Zillow analysis, using assumptions that reflect the new law, estimated that that only 14.4 percent of homes are worth enough to make itemizing pay off, down from 44 percent under the old code.
If you’re taking the standard deduction, “effectively, all that interest is no longer deductible,” said Benjamin Tobias, a certified financial planner and a certified public accountant, and founder of Tobias Financial Advisors in Plantation, Florida.
To gauge if your payoff plan needs adjusting, start by calculating the impact from rising rates and/or tax changes.
With a home equity line of credit, for example, it’s a one-two punch: The variable rates are rising and the interest is no longer deductible. Last year, a rate of around 4.5 percent probably had a true cost closer to 3 percent after factoring in the deduction, McBride said. This year, it could be closer to 5.5 percent, with no deduction in sight.
“That can be a pretty significant difference,” he said — enough that it might now be more of a priority than say, your 4 percent auto loan.
Then assess how any shift might reorder debts in your prioritization. Experts suggest ordering from highest-rate to lowest, with a focus on those non-deductible debts first. Credit card debt is still likely to be priciest, offering the most bang for your buck with payoff.
“Bottom line is, any debt that isn’t deductible, should be paid off before you pay off the debt that is deductible, assuming the rates are equal,” Tobias said.
Keep in mind that other factors can interplay.
For example, federal student loans typically offer more borrower protections and flexible repayment options compared to private loans, said Mark Kantrowitz, publisher of PrivateStudentLoans.guru. Nixing the latter first can help preserve your options if you struggle financially later in repayment.
Be aware of the opportunity cost of accelerating repayment, too. You might get a better return by boosting contributions to your tax-advantaged 401(k) plan or building an emergency fund (if you don’t have one) rather than trying to pay off your mortgage ahead of schedule, said McBride.
“Pouring a whole lot of extra cash into an illiquid asset isn’t the most efficient use of your spare money,” he said.
Make an effort to check back on your plan throughout the year. Future rate hikes and other changes to your financial circumstances may merit additional tweaks.