I was recently asked by a friend if it was better for them to pay down their mortgage or pay off their credit cards.

I answered him with a question of my own. I asked him if he was given the option of the following two investments which would he choose?

INVESTMENT A: guaranteed rate of return of 19%

INVESTMENT B: guaranteed rate of return of 5%

In this example, “INVESTMENT A” would be your credit card debt. Most credit cards charge interest of at least 19%. Therefore by paying down your credit card debt you are saving (earning) interest at a rate of 19%. “INVESTMENT B” represents your mortgage, since mortgage rates are typically under 5%. Therefore by paying down your mortgage you are saving (earning) interest at a rate of 5%.

Obviously in this example you would choose “INVESTMENT A” because all things being equal you would want to earn the highest guaranteed rate of return possible. In this example, the old adage “a penny saved is a penny earned” applies. When you’re trying to dig yourself out of debt paying the creditor that is charging high(er) interest first will allow you to save (earn) the maximum amount of interest.

If you are struggling with credit card debts, you want to make sure that you have a plan to become totally debt free. Many people that try to dig themselves out of debt on their own fall into the trap of “treading water”. What I mean by “treading water” is that they struggle to make payments, but they aren’t really getting out of debt.

I would recommend using my debt options calculator to review your debt repayment options to make sure that it is feasible for you to dig yourself out of debt on your own. If you find that you’re making payments but your total amount of debt is not reducing on a monthly basis then I would recommend reviewing your options. You may be better want to consider filing a consumer proposal.

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