Frequently, you may want to exclude home or student loans from this process. Interest on these types of loans create a tax deduction for the borrower, and consequently, the real interest rate being paid on these loans is less than the amount simply being paid to the bank or the educational institution. To figure out the real interest rate on these loans, multiply the nominal interest rate by one minus your marginal tax bracket. For instance, the real interest rate on a 6% marginal home loan for an individual in the 25% tax bracket is:
Accelerating payments on loan balances is extremely beneficial. Consider a $5,000 credit card balance with a 15% interest rate. An individual making a $100 monthly payment would take 6.6 years to pay off the loan, and cost $2,896 in interest payments. Meanwhile, if payments were increased to $150 a month, the loan would be paid off in 3.7 years and cost the borrower only $1,509 in interest payments.
Speak to an independent fee-only financial planner about putting together a schedule to eliminate your debts. The faster you eliminate your debt, the earlier you can begin to invest, and the better your retirement will be.