Climbing out of wedding debt

NEW YORK (Money) -- When we got married, my husband and I decided to have a big wedding that cost $40,000. To pay for it, we took out a personal loan for $20,000 at a 10% interest rate and put the rest on a credit card that initially had a 0% rate but now charges 12%.

We thought that, with both our salaries, we'd be able to pay off this debt in a short period of time. But my husband was laid off and is no longer receiving unemployment. We also have a house payment and a car payment, but beyond that no other debt.

I earn $76,000 a year and contribute 5% of pay to my 401(k) -- which has only a small balance -- to get the full employer match. What is the best approach to paying off this massive wedding debt? -- Julia, Illinois

Aside from giving a whole new meaning to the phrase "wedding bell blues," your situation demonstrates just how tricky taking on debt can be. A debt level that seems easily manageable when things are going well can suddenly become an albatross that jeopardizes your security if your finances deteriorate.

There are a lot of people out there who will see your situation as proof that all debt is inherently bad and that people should always avoid it. But as I noted in a recent column, I consider that view a bit extreme.

That said, you've got to be prudent about borrowing. In each instance, ask yourself whether it's truly justified and whether your overall debt load will put a strain on your finances.

As part of that evaluation, also consider "what if" scenarios: What if your income drops? What if the interest rate on a loan rises? What if you suddenly face other financial obligations? Would you still be able to handle the debt?

Investing when 'paralyzed with fear'

Clearly, we can't foretell the future. Nor would it make sense to go through life with a bunker mentality, living as if at any moment we could suddenly be thrust into a worst-case catastrophe. But when making financial decisions, we should still strive to leave ourselves some wiggle room so that we have a reasonable chance to weather setbacks.

In some instances, that calculus may lead us to rely on savings for a big expense instead of borrowing. Or we might downsize the expenditure in order to cut the level of debt we need to finance it. Or we might decide not to borrow money for it at all.

Perhaps you and your husband discussed those options and decided that it made sense to go ahead with your big wedding plans. Regardless, you may want to review your decision to see if there's anything you would do differently when facing big financial choices in the future.

Now let's tackle that Big Fat Wedding Debt. It's no mystery how to get out of debt (assuming you want to do so with your credit rating intact): You repay it. And to the extent you can also reduce the interest rate on what you owe, the payments you make will shrink the debt even faster. So the first thing I recommend is to create a detailed budget. (You can find several good budgeting worksheets at Google docs.)

Once you know exactly where all your money goes each month, you can then look for places to cut back in order to free up cash that can go toward repaying what you owe.

Be tough on yourself. Remember that with every extra cent you can devote to loan payments, the less you'll pay in interest and the quicker you'll pay down your debt.

One caveat: You're down to one income now, and should that disappear, you'll want to have a savings kitty of about three months or so in living expenses to fall back on. So if you don't already have such a reserve, build one before you start paying down your debt faster.

Once you've established your emergency savings, you can use the extra money gained from tightening your budget to pay off your debt. Funnel the extra cash to whichever loans carry the highest rate first. In your case, that would appear to be the credit card with the 12% rate.

Is a debt-free life the best way to live?

Another way to boost debt payments would be to stop contributing to your 401(k) and direct that money instead to repaying loans. But halting 401(k) contributions could come back to haunt you come retirement.

You would also be foregoing employer matching funds, which, depending on your company's generosity, can dramatically increase the potential effective rate of return in your 401(k).

So unless you absolutely must (i.e., there's no other way for you to make your payments), I'd recommend trying to dig your way out of this without disrupting your retirement planning.

The next step in paying down your debt is to see if there's some way to replace all or some of what you owe with a loan or loans that carry lower interest rates.

Send Walter Updegrave a question

That way, you'll get more debt-reduction bang for each payment you make. To find loans with better rates, you can try local banks or perhaps a credit union, as they often have very favorable rates.

Depending on how much equity you have in your home, you could also look into transferring your wedding debt to a home equity line of credit. Besides giving you a lower rate, this move would also likely make the interest on your loan tax deductible.

Keep in mind, though, borrowing against your home's equity means your house is on the line if you fall behind in payments. I'd also caution against getting too comfortable with the flexible repayment terms many home equity lines offer.

Remember, the goal here is to get rid of the debt faster, not to find a way to allow you to stretch it out longer. You can check out the rates on home equity lines as well as other loans by clicking here.

Beware, though, of pitches from companies that tout debt consolidation and other get-out-of-debt-quickly schemes. Some may be outright scams, while others can be riddled with high fees that make them a poor choice. Even offerings from legitimate lenders may not necessarily be a good choice.

When I recently test-drove the debt consolidation calculator of one large bank, I was offered a loan that the bank said would cut my overall interest expense. It did, but the new loan actually had a higher rate than the old loans. The interest savings resulted only from a shorter term and larger principal payments, which means I could reduce my interest costs even more by simply applying the larger payments to the old loans.

If you find that, despite your efforts, you're not making progress on paring down this debt, you might consider credit counseling.

One final note: When your husband gets back to work, that's when you can really start throwing extra payments at your loans and paring this debt more quickly. That would also be a good time to pump up that savings cushion so that you don't have to rely on debt as much in the future for big-ticket spending.