Time to get out of debt

(Money Magazine) -- Not so long ago, living a little beyond your means may have struck you as a downright sensible thing to do. Why not live well? Simply by owning a four-bedroom colonial you could sleep at night, knowing you could always tap your equity once those credit-card balances got a bit too high.

That gamble, you may know all too well, is no longer paying off. The housing bust and the credit crunch that followed the collapse in subprime lending have put an end to the house as piggybank - as well as to a lot of other tried-and-true borrowing tactics like swapping from one 0 percent teaser rate to another and finding cut-rate financing for that next plush car.

Editor-at-large Jean Chatzky appears regularly on NBC's Today. Contact her at money_life@moneymail.com.

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If you are in over your head now - and judging from the e-mail I get, plenty of folks with very good incomes are - you've got to think strategically about managing your debt portfolio so that it doesn't crush you. The three-step plan that follows can help you bear the burden.

It's gospel at Money to "pay yourself first," meaning that putting money away regularly into a 401(k) or other savings vehicle is your first priority. But if you're strapped, sometimes the best thing you can do is defer savings and instead plow every available cent into paying off debt until you get your finances under control.

"It blows my mind when I see people maxing out their 401(k)s while paying 30 percent on their credit-card debt," says Brad Stroh, founder of Bills.com, a consumer-finance education site.

First, let me fess up. About a year ago I went on the Today show and said that 40-year mortgages were a terrible idea. And usually they are, especially when people use them to buy bigger houses than they can really afford. But if you own a house and you're now tapped out, lowering your payments with a 40-year loan could be a good move.

Yes, you'll wind up spending more in interest charges, but if the alternative is falling behind in your bills and watching your credit score plummet or having to sell your house in a falling market, a longer mortgage is the lesser evil. And the longer payment schedule can be especially helpful if you're soon facing a reset of an interest-only mortgage that had a low up-front rate and the switch to a conventional mortgage is going to wipe you out every month.

Likewise, this is a time to consider repaying student loans over 20 or 30 years rather than 10, extending a three-year car loan to six (while promising yourself that you'll keep the car) and making minimum payments on your plastic. You're treading water.

Once your financial situation improves a little bit, you can either refinance the mortgage (again) or start prepaying loans to get you out ahead of schedule.

No, that's not an invitation to whip out the plastic and head for Nordstrom's. It's a reminder that if you're going to be borrowing money in this new era of tighter credit, you'll need to shop around more than ever for the best deal - particularly for a mortgage or home-equity loan.

"If you're looking for a jumbo first mortgage," says Keith Gumbinger, vice president of financial publisher HSH Associates (HSH.com), "the disparity on pricing is extraordinarily wide." Gumbinger has seen jumbos in the mid-8 percent range and others down in the mid-6 percent range.

If you're borrowing $500,000, that's the difference between a monthly payment of $3,160 and $3,844 - or $246,240 in additional interest over the life of the loan. For the best deals, shop locally. You may do better at a regional bank or savings and loan that underwrites mortgages rather than at a national lender that repackages loans for institutional investors, who have begun to avoid debt as if it were radioactive.

That's one Wall Street practice some folks on Main Street could stand to adopt.