Dear Liz: I just graduated from college and landed a job that pays $43,000 a year. Three years ago, I purchased two houses as rentals. To tell you the truth, my mortgage debt is high, but I have only $5,000 in student loans and about $3,000 in credit card debt. The mortgages have fixed-interest rates that are low.
Should I focus on paying down the mortgages or is it a big mistake to do that and lose the tax deduction? What do I do if the housing market crashes? Have I taken too much risk?
Answer: What’s important is not how much debt you have. It’s what kind of debt and how well you’re managing it.
Credit card debt, for example, is almost always a bad idea. The interest typically isn’t deductible and can be jacked up if you make a single misstep (such as paying late or maxing out your cards).
Many people erroneously believe that credit card debt is normal in America, but in fact Federal Reserve figures show the majority of U.S. households have no credit card debt, and the median balance among those that do is just $2,200.
Student loans and mortgages, meanwhile, are usually classified as good debt because the things they buy (education and homes) are considered investments.
As long as you haven’t overdosed on such debt ï¿½ by buying too much house or borrowing more for your education than you’ll make in your first year out of school ï¿½ you don’t need to be in any particular hurry to pay down this debt.
In fact, most people find there are much smarter uses for their money than paying down low-interest, tax-deductible debt such as mortgages and student loans.
You, for example, should be contributing at least 10% and preferably 15% of your gross pay to a 401(k) or other retirement account. You probably should have a fat emergency fund as well to cover those inevitable months when you’re between tenants and your homes sit empty.
Now, all this assumes that your rental houses are paying for themselves ï¿½ in other words, that the rents you receive cover your mortgages and other out-of-pocket costs. If that’s not the case, then your homes may not be building wealth: They could be eroding it.
Some people bought money-losing rental houses assuming that double-digit appreciation would bail them out, but those days are over for a while. If these homes are money pits, you may be wise to sell them while you can.
Credit card tax burden can be on employer