Like most people, you may be in debt. From student loans to mortgage payments, credit cards and car loans, Americans owe a variety of debts. How do you know what to focus on paying off first to avoid digging yourself into a financial hole and ultimately save yourself money in the long run? These best practices may offer some insight and guide you towards achieving your financial freedom.
1. Save for Emergencies
Making sure that you are prepared as possible for the unexpected is very important. Losing your job, getting injured or an unexpected expense are things that could easily force you into financial dire straits. It’s recommended that you try and set aside 3-6 months’ worth of your typical expenses. This greatly lessens the impact of any unforeseen expenditures.
A great practice is to open a separate bank account that is strictly for emergencies and set up automatic withdrawals from your checking account. Even just a couple hundred dollars a month adds up fast and leaves you so much more prepared for the unexpected.
2. Pay High Interest Credit Cards off First
Running up a high balance on a credit card can happen fast… and take a lot longer to pay off. Paying only the minimum each month means you’ll be paying mostly interest and doing very little to chip away at the card’s balance. If you are able to, make a larger payment each month: this practice can drastically cut down the time you take to pay off your loan.
How paying extra each month can make a HUGE difference: If you have a $5,000 balance and a 15% interest rate this is how your monthly payments can affect how much, and how long it takes you to pay that balance off:
|Months to pay off:||79||44||15|
|Total Cost with Interest:||$12,517||$8,365||$7,179|
Avoid using your credit card to finance large purchases – Using your credit card to make payments on large purchase could end up costing you a lot. For example, if you bought a $2,000 TV on a credit card with a 15% interest rate, and only made the minimum payment (say $40), it could take you more than 6.5 years to pay off and you would end up paying over $1,120 in interest. Just by doing this your $2,000 TV ended up costing you $3,120.
3. Pay the Monthly Minimum on government student loans, car loans and mortgages
While credit cards interest rates typically range between 14-18%, these types of debts usually have much lower interest rates and can be used as a tax benefit. Car loans are typically around 3%, student loans are right around 4% and are tax deductible, and mortgage interest is deductible for federal tax purposes and rates are right around 4.375-4.500% for a 30- year fixed loan. Because of the low interest rates and tax benefits, these types of loans are the least important to pay off as early, and won’t end up costing you as much in the long run as your higher interest debts.
We hope these tips are helpful in creating your strategy to pay off your debts and improve your saving. As always, please do not hesitate to reach out with questions about your particular circumstances and for help creating the right plan for you to achieve your financial freedom.