Find tax benefits from home ownership, student loan and investment interest
With so many people concerned about holding onto their jobs and keeping up with consumer debt payments, it's no wonder that more and more people are concerned about reducing their debt to manageable levels. The key to trimming your debt is just like any other diet: Cut your spending as you would cut calories and exercise more—in this case, exercise your self-control. The similarity to a typical diet regimen doesn't end there; the remedy is often easier to explain than to execute. But once you commit yourself to your goal, there are ways you can use the tax laws to slim down your debts.
The interest you pay on consumer debt falls into two distinct categories: tax-deductible and nondeductible. Mortgage interest and home-equity loan interest are generally tax-deductible. So is interest paid on student loans and money borrowed to buy investment property, including stocks, bonds and mutual funds, up to certain limits.
Interest paid on credit cards and car loans is not deductible. In theory, using a home-equity loan to pay off high-interest credit card debt is a good idea. For example, trading $10,000 of 18% nondeductible credit card debt for $10,000 of 7.5% deductible debt would slice the after-tax carrying cost from $1,800 to $540 a year for a taxpayer in the 28% bracket.
In reality, this strategy works best if you commit yourself to paying down your home-equity debt, and claim the tax-deductible interest on your tax return as quickly as possible, without allowing your zero-balance credit card statement to entice you to go on another shopping spree. Using your home as a piggy bank has its limits, and even tax-deductible interest costs money.