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Inheritance strategy: Pay off mortgage or credit cards?

High-rate credit card debt usually tops list of things to pay off

By Alan Klayman

Maturing Loans
Maturing Loans, Alan Klayman
Alan Klayman is CEO of Klayman Financial LLC. He served as a vice president at Fidelity Investments, worked as a financial planner for American Express, and built fixed income strategies on Wall Street at The First Boston Corporation. At CreditCards.com, he writes Maturing Loans, a weekly feature in which he answers readers' questions about retirement and debt issues.

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Question for the CreditCards.com expert

Dear Maturing Loans,
I recently inherited a sum of money, and I'm not sure what to do with it. I have three credit cards that are maxed out to over $22,000. I have a mortgage on my home with over $78,000 left on it. The amount of money left to me was over $150,000. I am 62 years old and thinking of retiring. Should I invest all of this money? Should I think about paying off the mortgage? How about the credit cards? That amount seems so small that I think I should get more cards and use them to furnish my house. What do you think? -- Bonnie

Answer for the CreditCards.com expert

Dear Bonnie,
Thanks for your question. There are a number of factors you need to consider when you inherit money. You have laid out many of them in your question, so let's review.

First, I would consult with the executor of the estate and your CPA, and double-check that all of the debts on the estate have been paid, including any potential estate and inheritance tax. You want to make sure that your inheritance is free and clear of encumbrances. Once you know that the money is yours, write down what are you trying to accomplish. As you stated in your question, you have debts that you are considering settling. You are thinking of retiring and need to know if you should invest this money. You also have a wish list of items, including buying some furniture and doing some remodeling.

Start with the credit cards and the mortgage. You want to settle debts in the order in which you pay the most in interest cost. If you are like most people, your credit cards carry a higher interest rate than your mortgage, so go ahead and pay those off first.

Next is your the mortgage. Paying down a mortgage comes down to two things: Does it make sense mathematically, and would you feel better knowing your mortgage is paid off?  For example, if your mortgage has a 12 percent interest rate, and the current going rate for a 30-year fixed mortgage, as of Aug. 25, is 6.47 percent, then either pay it off or refinance at a lower rate.

But what if your rate is only a 1 or 2 percentage points higher than the national average and you're more interested in generating investment income during your retirement? Then you might want to keep your mortgage and invest the money. Keep in mind there are different types of investing -- variable and fixed. Variable investing is where you can't only make money, but you can lose money. Stocks, mutual funds, exchange traded funds (ETFs) are among different types of variable investments. With fixed investments, you receive a fixed rate of return and there is some type of assurance that you receive your money back after a period of time. Fixed investments include government bonds, bank CDs, and fixed rate annuities, among others.

When doing your mortgage comparison you want to look at other fixed rate instruments, not variable, as places where you can invest your money. With a 5 percent mortgage, your rate may be 3 percent or 4 percent after taxes (check with your tax adviser to see your actual after-tax rate). If you are paying a 3 percent to 4 percent net mortgage versus earning 4 percent on fixed rate investment vehicles today (i.e., CDs, long-term government and corporate bonds), then mathematically, this doesn't justify either keeping or discarding the mortgage. If you are paying after taxes what you would earn after taxes, then it really comes down to the question of whether you would sleep easier at night knowing your house was paid for. If the answer is yes, then pay off the mortgage.

Paying down debt on credit cards and on other debts is just as helpful as investing that money when planning to retire. Remember the old saying, "a penny saved is a penny earned?" Or for our sports fans, "A walk is as good as a hit."

One more thing. Once you have paid down the appropriate amount of debt, go back and renegotiate your credit terms on your cards. If you can't, then look for rewards cards and low interest credit cards that pay you in the form of lower rates and rewards. Once this is done, Use your cards, and pay them off in full each month.

Then if it is in your budget, get that new furniture.

Thanks for the question, see you here next week.

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Published: August 26, 2008


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