Your client has a $320,000 mortgage, $28,000 car loan, $45,000 in student loans, and $14,000 on two credit cards. She asks, "Where do I start?" The answer is not just about paying things off, it is about sequencing, tax efficiency, and knowing when debt is a tool versus a trap.
Every financial plan must account for debt. The CFP Board tests your ability to distinguish debt types, evaluate trade-offs, and know when debt is a tool versus when it is a trap.
HIGH-FREQUENCY: HELOC deductibility, avalanche vs. snowball, and refinancing breakeven are the three most tested debt topics.
An adjustable-rate mortgage (ARM) starts with a fixed rate for an initial period (commonly 5, 7, or 10 years), then resets periodically. A 5/1 ARM holds its rate for five years, then adjusts annually. The risk is payment shock at reset.
Debt is productive when the after-tax cost of borrowing is less than the after-tax return on the asset it finances and the client can comfortably service payments.
Common mistakes
- Assuming HELOC interest is always deductible. HELOC interest is deductible only when proceeds buy, build, or improve the home. If the client used a HELOC to consolidate credit card debt, pay for a vacation, or buy a car, the interest is not deductible.
- Confusing IDR and PSLF tax treatment. IDR forgiveness after 20-25 years is taxable income. PSLF forgiveness after 120 payments is tax-free. A teacher with 120 qualifying payments gets tax-free PSLF forgiveness. A private-sector worker after 25 years of IDR owes tax on the forgiven balance.
- Dividing the refinancing breakeven in reverse. The formula is closing costs divided by monthly savings. Trap: $128 / $6,000 = 0.02 months. The correct answer is $6,000 / $128 = 46.9 months.
Bottom line
- HELOC interest is deductible only when proceeds are used to buy, build, or improve the home, the exam's favorite debt trap; otherwise the cost equals the stated rate.
- Consolidating credit cards with a HELOC eliminates the interest deduction and converts unsecured debt to secured, putting the home at risk.
- Refinancing breakeven = closing costs divided by monthly savings = months to recoup.
- After-tax borrowing cost = rate x (1 - marginal rate), but only if the client itemizes.
Exam shortcut
The CFP Board loves refinancing breakeven, simple division but easy to rush. Confirm you are dividing closing costs by monthly savings, not the reverse. For HELOC questions, if the proceeds leave the house, the deduction leaves too. For PMI questions, read the verb before the number. "Must" or "automatically" is the servicer's duty at 78%. "Requests" or "may cancel" is the borrower's right at 80%.
The full lesson (about 3,620 words, 24 min read) adds 2 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- B.10
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