Use Your Rebate for Debt Reduction

The U.S. economic stimulus checks are on their way, and many taxpayers have already decided to use theirs to pay down debt.

Free money has a remarkable effect on consumers-it persuades them to buy luxuries that they'd normally avoid. This is exactly what the federal government hopes you'll do when you receive your economic stimulus check. But if you've already done too much splurging, you're better off sending that check straight to your credit card company.

Back in January, our congressmen and women agreed to hand out $152 billion to taxpayers, hoping that they'd go on a spending spree and revive the economy. The checks are being sent out to taxpayers who have a qualifying income of at least $3,000. Eligibility starts to phase out for individuals with adjusted gross incomes in excess of $75,000 and married couples with adjusted gross incomes in excess of $150,000.

Debt plus inflation equals caution

A recent Harris Poll indicated that 38 percent of the respondents intend to use the stimulus money to pay down debt. This is hardly surprising, considering that statistics peg average household credit card debt at about $8,500. Assuming an interest rate of 12.99 percent, and minimum payments of 2 percent of the outstanding balance, it can take up to six years to pay off $8,500. And that's just the credit card balance; these same consumers have other types of debt to manage, including loans for colleges, cars, and mortgages.

The pinch of high household debt balances is aggravated by rising food and gas prices, as well as a generally uncertain economic climate. All these factors combined are likely to keep many households from buying new TVs, video game consoles, and kitchen appliances with their stimulus money.

The impact of debt pay-off

If your household is eligible, your stimulus payment will probably be between $300 and $1,800. While that may not be enough to pay off your debt, you'll benefit from using the money to make a partial payment on your accounts. Such a payment functions like a mini debt consolidation loan by reducing the minimum monthly outlay, or shortening the pay-off cycle. Going back to the example used above, a one-time payment of $1,800 used against a balance of $8,500 has the following impact:

• Where the minimum payment is 2 percent of the balance, the payment will be reduced from $170 to $134. If the minimum is 4 percent of the balance, the payment drops from $340 to $268.
• If you ignore the payment reduction and continue paying the same amount every month, the debt will be paid off up to 21 months faster.

Since tight credit markets have made debt consolidation loans harder to come by, you're wise to act on any opportunity available to reduce debt-even if it means forgoing the luxuries your government expects you to buy.