Getting Started: Paying Off Emergency Debts

Earlier we talked about tracking your finances and budgeting. Today we’ll discuss paying down high interest debt.

Now that you’ve got a handle on your month to month expenses and can start projecting out your cash flow, that will allow you to funnel the savings to increase your net worth (or in this case decrease your net liability) – and let your money work for you.

What is High Interest Debt?

Well typically we’re talking about credit card debts, personal debts, consumer loans, balance transfers or other debts that charge a relatively high interest rate. Personally, I would consider many car loans and nearly everything other than mortgages or subsidized school loans to be in this category.

What About Emergency Savings?

Most financial outlets will tell you to save up an emergency cushion for a rainy day. The point of emergency savings is to avoid having to tap high interest loans or debts to cover expenses. Therefore if you already have high interest debt, this is an emergency! There is no point in saving for some future emergency when your financial house is on fire!

If you have any savings that aren’t holed up in some retirement accounts or would cause penalties to tap, you should be tapping them to pay off this debt.

Let’s put it this way. You have $100 a month that you can save towards some future emergency. It will earn less than 1% in any “high interest” savings account you can find nowadays. OR you can pay off your debts and earn a guaranteed return equal to the interest rate. Today that stands at 13-15%!!!

If you spend a year saving that $100 a month, you’ll end up with around $1,206.52. Pay the debts off and you’ll have saved $1,287.95 to $1,302.11.

Paying Them Off

You’ll see a number of sites dedicated to this process, but the idea is pretty simple. Pay off your highest rate debts first (known as debt stacking). You’re getting the most bang for your buck. Unless you have a ton of bills and debts and it is hard to track them all and pay them all on time, I wouldn’t recommend paying off the smaller balances for “mental peace” (known as the snowball method). You’re wasting money if you’re not paying the highest rate debt.

Resources

There are some sites available to help you pay off debts:

  • Ready For Zero is a “freemium” site where it helps you track the process and links up accounts. You can pay for an upgraded premium account to automate the payments and get updated credit scores.
  • Savvy Money is another site that will track your debts and bills, generate a payment plan, and track your progress.

 

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  1. Pingback: Getting Started: Building Up Emergency Savings for Rainy Days | Big Day ComingBig Day Coming

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