Alternate title: When is $3,600 worth less than $3,600?
This process is full of debt paradoxes. First off, it is a paradox that by borrowing scads of money, I will end up keeping more of what I earn. This is thanks to federal tax incentives that make the interest on my mortgage tax deductible. It doesn’t sound right at first – borrow over $100,000, end up with more cash to spend – but sure enough, that’s how this works.
The next paradox is a result of how lenders evaluate a borrower’s debt to income ratio. They look at the monthly debt payment and compare it to your monthly income. They do not look at your total amount owed relative to your total annual income.
Take me, for example. One debt I have is a $3,600 student loan. The current monthly payment on that debt is $52, which is pretty darn low thanks to the income based repayment plan. If that debt were instead credit card debt, with an interest rate of 18%, the minimum monthly payment would instead be $90! I used bankrate’s calculator to get that number.
Now, say I have a few thousand dollars to play around with and use to pay down debt. If I paid off my credit card debt, that would have almost twice the benefit to my debt to income ration that paying off my student loan debt would have. So far, so good right?
Here’s the thing. I don’t have credit card debt. I only have “good debt.” So I just get a measly $50 off of my monthly debt:income ratio if I pay that $3,600 debt off. Student loan debt doesn’t seem like such good debt to have now! Strange but true.