Tackling Debt While Saving
Most people have a variety of debt – credit card balances, auto loans, mortgages and student loans to name a few. What should you be paying off first and how could you possibly save at the same time?
The most important thing is to make sure you’re paying your minimum amounts on time to keep loans from defaulting. You don’t want to ignore a credit card statement or a loan payment and risk ruining your credit score or bankruptcy. Setting up automatic payments will help keep you from ever having to worry about incurring late fees or lowering your score.
Here are some ways to help pay off debt while saving things like emergencies and retirement
Make an Emergency Bucket
You want to be prepared in case the unexpected happens and a big expense hits you. Losing your job could put you in the red, which could take years to pay off. Every person’s situation is different but a general rule of thumb is initially saving for 3 to 6 months of expenses to have just in case. You can set up small automatic payments to deduct from your paycheck or push to your savings account that will help you fund your emergency bucket.
Contribute to a health or flexible savings account if you are eligible
If your health plan has a high deductible, consider contributing to a health savings account (HSA) or flexible spending account (FSA) that can help cover your anticipated healthcare costs for the year. If you are not sure how much you need, then at least contribute enough to cover your deductible—you can always change your contribution amount if you find your actual expenses are higher or lower than expected. By putting money into this bucket up front and paying for qualified medical expenses out of an HSA or FSA instead of paying those expenses out-of-pocket throughout the year you are effectively converting after-tax health care expenses into pre-tax expenses, and saving money to use to help pay off debt.
Get your free money through a 401(k) employer match
Yes, debt may be staring in your face but if your employer matches money you put into a 401(k) or 403(b), don’t pass up on that free money. Let’s say your company matches 50 cents on every $1 you contribute, up to 3% of your salary. If you make $50,000 a year and contribute 3%, or $1,500, your company kicks in another $750. If you do that every year, in 10 years that $2,250 a year could grow to more than $32,000, assuming a hypothetical return of 7% per year.
Tackle Credit Card Debt First
It’s very easy to run up a balance on a credit card… or five. And once you do, it’s not easy to pay it off. When you pay minimum balances, you’re mostly paying down interest, which means it will take much longer to pay off the entire debt total, and it will cost you more. Try to pay off more than the minimum each month.
Avoid using a credit card to finance big purchases, since, sometimes, it could double the cost of the purchase. A $2,500 computer could end up being a lot more once you figure in the 15% interest rate on your credit card. In instances like this, it’s good to find financing with the seller of the product, which usually gives a zero percent interest for a certain number of months (6-18, usually) as long as you make the minimum payments on time and pay off the debt within the term length.
Next up: Student Loans
Private student loans for college carry higher interest rates than government student loans, in general. Currently, rates on private student loans are from 5% to 13% compared with about 4.81% for government undergraduate student loans*. You may be able to deduct the interest on a student loan, however, but only up to $2,500 a year, and only if you are a single filer earning less than $80,000 or $165,000 for married filing jointly. If you make more than that, you won’t be able to deduct the interest. As a general rule, you should be paying down any student debt above 8% interest first.
Pay a monthly minimum on government student loans, car loans, mortgages
These types of loans have lower interest rates, and some offer tax benefits. That’s why it generally makes sense to make only the minimum monthly payments on these loans. For instance, mortgage interest is deductible for federal tax purposes and is at 4.50% for a 30 year conforming fixed loan right now. Car loans are about 4.2%. Government undergraduate student loans are currently 4.81%, and the interest may be tax deductible. If you are good about making payments, you may want to extend low-interest government student loans to lower your minimum payments and use the savings to pay down higher-interest-rate loans faster. Contact your loan servicer for information.
You can do this, you just have to stick to your plan. Paying off debt is important. It can be difficult to save when a giant portion of your paycheck is going toward debt repayment. That’s why it’s important to have a plan to get out of debt—it can save you money in interest and ultimately help you save more and reach your goals faster.