1/29/2013 8:15 PM ET|
Should you save or pay off debt?
If you find yourself with a little extra cash, where will it help you the most? These 5 questions can help you make the right decision.
If you're lucky enough to have some "extra" money in the form of a recent raise, unexpected gift or freelance earnings, you might be wondering how to spend it. Should you put it toward paying off debt, save it or splurge?
The savings-versus-debt debate is a common one, so let's take a closer look at which option makes the most sense. Here's a five-step guide to making the smartest money moves:
No. 1: Do you already have an emergency savings account? We all need an emergency fund, even if we still have high-interest credit card debt to pay off. That's because emergencies can happen at any time -- we could suddenly need a root canal, a plane ticket home or washing machine repairs. At a time when credit is tight, we can't necessarily count on credit cards and other sources of loans to be there when we need them, so we need a stash of cash for these types of emergencies. You should aim to have at least three months' worth of expenses stored away.
Even if money is tight or you're just out of school, putting a portion of your paycheck aside for a rainy day should be a top priority -- even more important than paying off debt. If you already have an emergency savings account, continue to the next question.
No. 2: How much is your debt costing you? Many people don't make this simple calculation, but it shows just how costly debt is. To do the math for your own, make a list of all your loans -- auto loans, mortgage, credit card debt and anything else you owe on.Next to each amount, write down the interest rate. (If you don't know off the top of your head, look it up!) Multiply the two numbers -- that's how much each loan is costing you per year. A $10,000 car loan at a 6% rate costs about $600 a year. Keep that number in mind as we move on to the next step.
No. 3: How much would your savings earn? If you do save this cash infusion, where would you put it? In a bank account that's earning a 1% return? Or into a money market fund, which might pay you more? In the current market, it's difficult to earn much more than 2% without taking on more risk. Pull out your notepad again and write down the total amount of cash in question, then multiply it by the rate of return you could get on the money.
Now, take a moment to compare your findings from steps two and three. Would paying off a chunk of your debt save you more money than you could earn by saving the cash? If so, then you're better off getting rid of the debt. That's a valuable piece of information that will help you make the final decision.
No. 4: What are your expected earnings in the near future? If you expect to receive an additional windfall in the near future, in the form of a freelance check, gift from parents or any other income boost, you have a little more flexibility. If you'll have more money to work with soon, perhaps you can pay off debt as well as save.
No. 5: What are your financial goals? If you have big plans that require a lot of cash, such as starting a small business, buying a house or traveling around the world, you probably want to pad your savings account so it contains more than just an emergency fund. Of course, paying off debt can also be helpful, because then you can embark on these new financial adventures without the added weight of old loans. But you still need cash to make those big goals happen.
The final answer will depend on how you answered the questions above -- and it might involve a mix of spending, saving and paying off debt.
More from U.S. News & World Report:
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Pay off your debt after getting at least $1,000 in savings.
Then, after that $1,000 is saved, Pay off all your debt and get rid of your credit cards.
Once you are debt free, save 3-6 months worth of living expenses in a money market account.
Finally, start a sinking fund for each item you know that you will have to pay for in the future. A new car, home repairs, college, weddings, vacations, etc should be in that sinking fund. A sinking fund is like a personal pre-paid debit card that you control. The money just sits there. Properly done, the sinking fund should be filled about the time you need to use it. For example, if you're planning on buying a new car in 4 years, estimate the cost of that new car and divide it by 48. That is your monthly contribution to the car fund. So if you want a $25,000 car, that would be about $521/mo. Of course, you'll have your old car you can sell, so if you get $4,000 for it on a private sale, that monthly amount would be only $438/mo. On a traditional 48 month car loan at 10% you would be paying $533/mo. Whatever is left over should be invested in a good mutual fund.
When the sinking funds are full, use whatever you're not putting into those to increase your investing.
No debt = no headaches.
If you have already been near foreclosure on your mortgage, and your credit card companies have closed your accounts, why are you paying them back the full amount you owed when the accounts were closed? With your credit score already in the dumper and another 200+ point drop for the mortgage being deliquent--what have you got to lose? Negotiate a settlement with the card companies for half (or less) than the balance and pay them off. Granted, you'll have to pay taxes on the settled unpaid balance, but it will probably not be as bad as paying the entire debt. Also, check with a tax professional to see if you qualify to file as "insolvent" during the year in which you paid the cards and got behind on the house. There are a lot of alternatives to getting out of the credit crunch that has affected all of us (caused by the Wall Street crooks and the banks) --we're all paying for it in a lower standard of living, stress, health issues, suicides, and quality of life.
Our economy has been permanently changed for the worse by an unregulated banking industry and sheer human greed.
Unlike Washington D.C., I try to manage our debt and to live within our means. Too bad those 636 fools never learned that lesson.
What we need is a "Balanced Budget Amendment" and TERM LIMITS!.
I guess I should have just saved it all and said "to he!!" with getting a better job (since most high paying companies check credit).
What a stupid report.
Pay your bills, talk with the companies you owe to, they are all willing to work with you now, some is better than none in the companies eyes now.
3 things that will kill your credit no matter what you do, owing the IRS, a student loan, and owing for traffic fines/parking tickets/court fines. These 3 things can murder your credit.
Another way to avoid heavy debt, don't live "Hollywood" if you're only working at minimum wage.
Lots of advice here, and most of it comes from someone's book or course. Bottom line you must do both, if you only focus on paying down debt you have no money for an emergency. If you only focus on savings you never pay down your debts.
Use a debt snowball taking a balanced approach to saving and paying down debts, it's not an all or nothing approach it must be balanced doing both. And, $1000 in savings is a joke by Dave Ramsey, $1,000 isn't an emergency fund but a joke, because people stop at the $1,000 thinking they have enough........Dave is a joke, a real emergency fund is at least 6 months gross income in the bank and for self employed people it should be 12 months gross income.....
This reporter has no idea what she is talking about, the five steps she is talking about only happens in the prefect world. This is not the prefect world. This is the easiest way to reduce your debt.
One: If there are two cars in the family and one is close to being paid off that is the debt you pay off first. After the one care is paid off you now have spendable income, which is the car payment you were making. Example, if your care payment is 500.00 dollars and you have paid off your car you now have 500.00 more. This money can be used to pay off credit cards or any other debt.
Two: After the first care has been paid off you do not let me repeat your do not purchase a new car because you just got out of debt on the first car. This is where people make the mistake they go out and buy a new care and start all over again and now have a high car payment. Do not buy a new car for the next 5 years. Sure there is going to be maintenance on the car because you don't have a warranty anymore. The better you take care of your care the least maintenance you will have.
Three: If you have large credit card debt the first thing you do is to stop buying stupid things on credit. Now in step two you have 500.00 additional income so this money could go to pay off your credit cards. In order to pay off your credit cards is to go on a "cash basis" meaning you will pay cash for everything. If you don't have the cash you don't get it and don't use the credit card. This is one thing that people don't know or don't think about is that "when you use your credit card and you charge something you had better have the money to make the payment on the item that you just purchased. If you don't have the money and you are runing up credit card debt your just digging your self into a larger hole.
Three: If one of you are making more money than the other this is the check to be use to pay off all the car notes and credit cards. The second check is use to pay all the house hold expenses. In the article the reporter doesn't mentiond using the your debit card to get cash, now this is where a lot of people get into trouble is because they forget to enter the amount into their check books and and write checks without knowing about the money they had with drawn from their checkiing account.
Four: Never rely on future income because you don't know what the future holds this is where the reporter is dead wrong. She mentions the rainy day or emergencies when emergency money would be needed. Now listen very carefully this is where you have a credit card that has no balance. but make sure that the credit card is only used every six months because if you don't use the credit card the credit card companies will deactivate for none use. This credit card is never to be use only in emergancies.
Five: This is best of all, the best credit card to have is "American Express" the reason why I say this is because is when the bill comes you pay off the balance on every charges you had made. I know that "American Express" is a hard card to get but there is a way around it. If you travel for your company and you use your own credit ask your employer if you can have an "American Express Corporate card". The card is backup by your company but you are responsible to make the payment but your company will reimburse you. All long as you make the payment on time "American Express" sees this and in the furture you will be able to get an "American Express Card".
What I have just said is what my wife and I do. "If there's no mons there's no funs" it's just that simple. In today's world you can"t rely on future earnings because you don't know what the furture will hold. Plan only for the present year. Don't do what the United States Government does is that they spend money on futrure money that the government dosen't have. The goverment has to many people handling the check book . If you follow my plan you will get out of debt.
Financial goals: "traveling around the world; starting a business"--ha-ha-ha-ha-ha. How about keeping the bank from forclosing as a financial goal; do you have a suggestion for that? How can a family save money when both parents have been out of work for years? Your financial suggestions are obviously aimed at "upper class" people with incomes. That's great for them but what about those of us who've been financially squeezed out of middle class? It's hard to plan how to save money when one has to decide which utility bill doesn't get paid month after month. A bigger, better plan is needed. Let's start by providing jobs for those who want to work; then we'll talk about savings and financial goals.
Signed by the embittered and crushed American Dream.
still waiting on the zombie apokolypse
This is by far one of the most practical financial bits I've seen in a very very long time.
It blows me away when I see people with huge amounts of debt focus on investing their money when there is just no way they can make what they are paying the bank in 99% of the cases I've seen. Completely nuts.
This article nailed it for the vast majority of people around the world (obviously there will be some exceptions)
1) Have a "safety net" set aside for emergencies it should be enough to handle car problems or medical deductable, etc. That tends to be right around $1,500.
2) Pay off your debts before worrying about investing once you've got your safety net built up. Nail the biggest interest rate items first unless there are some side costs that can be hacked away such as mortgage insurance on a home loan.
3) Once you have your debts cleared, put that same spare money into investments, just make sure to not put all of it in "high risk" investments.
4) Retire at a decent age, enjoy life, take on a "fun" job for kicks and some bonus vacation cash, keep your current job but have no worries about financial security, your call.
IF HOUSE MORTGAGE RATES WERE NOT SO HIGH EVERYONE COULD THRIVE A LITTLE EASIER EVERY MONTH PEOPLE PAY THOUSANDS OF DOLLARS ON INTEREST RATE ON MORTGAGES AN HARDLY ANY OF THAT MONEY GOES TO ACTUALLY PAYING OF A HOUSE MY MOM AND DAD HOUSE ONLY COST ABOUT 29,000 DOLLARS BACK IN THE 1972 AND IT 2013 AND THEY ARE STEAL MAKING PAYMENTS ON 40 YEARS LATER AND HAVE NEVER MISSED APAYMENT. ALL THIS TIME .
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