Portfolio makeover: Is our big debt doing us in?

(Money Magazine) -- Marc and Sharon LeRoux always dreamed of opening a business together. They took the plunge in 2006, tapping home equity to buy a franchise selling pre-made meals to busy families. Alas, the business failed, and last year the couple closed it down.

Fortunately, neither had quit their day jobs - Sharon is an engineer at Hewlett-Packard, Marc owns a specialty game store. But they still have $154,000 on a home-equity line of credit from the venture dragging them down. "Our income is very good, but we're living paycheck to paycheck," say Sharon. "And I'm sure we're underfunding our retirement and our kids' college." (They are parents of Marie, 15, Nicole, 12, and Marc, 5.)

That debt is indeed an obstacle, says Salem, Ore. financial planner Ron Kelemen. It eats up $1,000 a month. In spite of that, they've been keeping up with retirement, managing to stash away $12,000 a year. At that pace, says Kelemen, they'll have about $1.25 million by age 65, assuming a 7% average annual return (which they may be able to get if they build more growth into their portfolio).

The good news: That amount, along with Social Security, should be enough for their modest income goals. The bad news: They've been unable to start an emergency fund - savings that are essential in such uncertain times. As for college, they're aiming to have saved a year of state-school tuition for each kid . While they can probably get there, wiping out the HELOC would allow them to cover even more.

Accelerate payoff. More than half the HELOC is at an 8.4% rate; the rest, 4.2%. They should ask their lender about allocating payments to the higher-rate debt.

Boost cash reserves. With a car loan and Marc's day-care needs coming to an end soon, the LeRouxs will have $1,100 freed up every month. Kelemen suggests using $160 a month toward college - to hit their goal of one year per kid - and the rest to build a six-month emergency fund .

Invest for growth. At their ages, the LeRouxs shouldn't be so deep - 43% - in bonds. Part of the problem: More than a third of Sharon's 401(k) is in a stable-value fund. She might trade some of that for international stock funds like Dodge & Cox International (DODFX). Also, Marc's IRA is in a target-date fund meant for those who will retire in 2020. (It gets more bond-heavy as it nears that year.) He should switch to T. Rowe Price 2030 (TRRCX), a Money 70 fund now 86% in equities.

Downsize, later. The LeRouxs are considering trading down their five-bedroom house to tackle the debt. They think they could sell it for $360,000 today. That would cover their $168,000 mortgage and the HELOC; but with commissions and closing costs, it won't leave them with a down payment. A better plan: Wait to put the house up for sale until the market improves and they're likely to come out ahead. Once the HELOC is gone, that $1,000 a month can go toward their emergency and college funds.