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Mailbag Monday: Paid off Debt; Now What?

Paid InvoiceMy husband and I have recently paid off our credit card debt. So exciting! We set a goal and stuck to it over 24 months and it feels great to be debt free! I went back to work part-time to help with this and really like my job and plan to stay.

My question is about prioritizing our spending. Now that we have an extra $1,200 a month we no longer need to put toward debt, I’d like your advice about how to prioritize. A few considerations:

Could you help us? The mortgage concerns me, but I want to use my salary to its potential!

— Laura

Laura, congratulations to your family for paying off that credit card debt — that’s a big accomplishment. Isn’t it great that you now have this extra money to play with? The first thing I always want to note — so you may have heard this from me before — is that I want to see you with an emergency cushion, so you don’t end up back in debt when an unexpected expense pops up. So let’s put three to six months’ worth of expenses aside in a liquid account, if you don’t have an emergency fund already.

Next is retirement, and it sounds like you’re doing really well there. Even so, I’d run your numbers using my retirement calculator to see where you stand — the calculator will tell you how much you should be saving each month to reach your goals. If it tells you you’re behind, then yes, stashing some money in a Roth IRA is a good idea.

I also think it’s okay, at this point, to put some of that cash toward your vacation, so you can pay for that outright instead of using credit cards (though it may be a good idea to use credit cards when traveling to earn rewards, as long as you trust yourselves to pay off the balance in full when you get back). I’d also start saving for that car — in fact, if your emergency fund is set, I would split the difference between those two goals: $600 toward vacation, $600 toward the car. If you are still working on that emergency cushion, you can still put a little toward these goals, putting $600 into the emergency fund and $300 each toward the car and vacation, so you feel you’re making progress on all fronts.

Then let’s talk about that mortgage loan and the home improvements you want to do. Based on the information you’ve given, Whit Douglas, a mortgage lender with Corridor Mortgage Group, says paying toward principal is probably not a priority at this point. “I wouldn’t recommend making extra principal payments with how low interest rates are right now — and even more so in this scenario, when you will only be in the home for two more years.” If it makes you feel better, consider that under a traditional mortgage, payments during the early years primarily go toward interest, anyway. It often makes sense to pre-pay principal under an interest-only loan if you’re planning to stay in the house for a long time — your payments will jump after the initial interest-only period, and this can soften the blow — but in your case, your money could work harder for you elsewhere.

Finally, to address the home improvements: unless these are going to add a great deal of value to your home (in other words, you’ll get a large return on your investment when you sell), you’re likely better off living with your home as is and looking for the qualities you desire in your next home. Remodeling magazine publishes a yearly cost versus value report on common projects, which can help guide you in determining how much of the cost of the project you might recoup when you sell. You’ll note that none of the projects listed are able to recoup 100% of the initial outlay.