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Will you really use the stimulus package windfall on debt?

Americans say they'll take rebate money and pay off debt. Yeah. Sure.

By John Egan

You say you'll apply your windfall from the new federal economic stimulus package to pay down debt? You're not alone. Personal finance experts recommend that course. Consumers swear in multiple polls that they'll take it.

Will you really use the economic stimulus windfall to pay down debt? Yeah. Right.Recent evidence, however, suggests we'll have a hard time resisting the urge to splurge.

President Bush on Feb. 13 signed into law a $168 billion economic stimulus package whose mainstay is tax rebate money -- as much as $600 to singles and $1,200 to married couples, with an additional $300 for each child. It goes beyond tax rebates: $300 checks will go to disabled veterans, the elderly and other low-income people; and tax breaks are aimed at getting business owners to invest. Singles earning more than $75,000 and married couples earning more than $150,000 won't be eligible for the money. Checks are scheduled to start being sent out in May.

While merchants hope you'll plunk down the windfall in stores, on a high-definition TV or perhaps even a vacation, experts advise using the extra dough to pay down debt.

"Chances are that the television won't last that long and the memories from a vacation will be faded long before the credit card is paid off," says Elizabeth Schomburg, senior vice president of Family Credit Counseling Service, a Rockford, Ill., Christian-oriented credit counseling firm. "You'd have the peace of mind knowing that if you were to find yourself in a financial crisis, you would have one less bill to pay. And we all know that it is hard to put a price on peace of mind."

Benefits of paying off debt
Common credit card wisdom says to pay more than minimum payment every month until the balance is gone. Paying down the balance in big chunks, such as with your stimulus package check, will save you hundreds of dollars in interest and shorten loan's length dramatically.

Here is an example of how much money you could save by putting that money toward credit card debt.

How one extra payment can slash debt
Thinking of applying the economic stimulus windfall toward debt? It's a wise move. Here's how a single $600 payment can reduce interest costs and trim the time until payoff.
Debt Monthly payment Months until debt is paid Interest paid Total paid Savings
$2,000 $40 94 $1,724 $3,724 --
$1,400 (after $600 lump sum) $40 51 $601 $2,601 $1,124
Source: CreditCards.com calculator, "What will it take to pay off my current balance?"

"Consumers should try not to look at the rebate as an unexpected gift, but as money that can go toward their financial goals," says Sandra Shore, senior counselor at Novadebt, a New Jersey credit counseling agency.

Pay high-interest debt first
When considering how to spend your extra money, keep in mind this tip from experts: Pay off any high-interest debt first rather than depositing the money in a CD or another interest-bearing investment vehicle. The money you could earn in an interest-bearing investment will most likely be much lower than the interest rates on your credit cards, which effectively negates any profit you earn on your investment. Look at all of your debt, too, not just credit card bills, experts say.

Lightspeed Research surveyed 2,134 Americans in late January; about half said they plan to use their additional funds primarily to reduce debt. Of those, 80 percent intend to shrink their credit card bills. Subprime consumers -- whose economic woes have contributed to higher rates of credit card delinquency -- were most likely to say they would pay down debt (60 percent), compared with fewer than half of consumers with top-notch credit scores.

Separate surveys for TrueCredit.com, American Century Investments and UBS Securities indicate that roughly four of every 10 Americans will set aside their windfalls for debt reduction.

Quick fix?
Mark Nelson is among the four in 10. Nelson, an eighth-grade history teacher in San Diego, says he plans to use his expected $600 rebate to pay down a loan he took out in October at 6 percent interest to consolidate credit card debt. He put up his 2003 Honda Accord EX as collateral.

Nelson says his credit card debt doubled -- from about $7,000 to $14,000 -- within a year after he began dating his current girlfriend. However, Nelson acknowledges the debt probably would have crept up even without a girlfriend "because I have champagne taste on a beer budget."

How we used the 2001 rebate
If a November 2007 study of how Americans used the 2001 tax rebate is any indication, then Nelson is typical: Despite our stated intentions, Americans' vows of fiscal responsibility don't last long.

The study by the Federal Reserve Board of Philadelphia looked at credit card data, and about how Americans handled their card balances in the nine months following receipt of their checks. It showed consumers did as the experts recommend: They initially earmarked their 2001 federal tax rebates for debt reduction. On average, debt went down for a few months. But by the fourth month, debt leveled off, as spending picked up and extra payments fell. By nine months after the rebate, overall debt was higher than it was before.

"We find that, on average, consumers initially saved some of the rebate by increasing their credit card payments and thereby paying down debt," the economists who wrote the report concluded. "But soon afterward their spending increased,"

This time, we mean it
Standard & Poor's economist David Wyss predicts Americans will be more conservative with their rebate money this time around, mainly due to nervousness over the unstable housing market. Still, Wyss says, "a lot of people will fritter it away, like most of us do. There's always a tendency that when people get a windfall, they spend it."

"But still, about $25 billion will head into the spending stream," economist Michael Niemira says, "and that is positive for the economy."

Related stories, tools: "10 wacky ways to spend economic stimulus windfall," "10 wise ways to spend economic stimulus windfall," "Even those who saved ended up spending," Credit card calculators

 To comment on this story, write editors@CreditCards.com.

Published: February 13, 2008


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