When you are sitting at your desk, staring at a big stack of bills and a paycheck that may not be quite as big, how do you decide what bill to pay, and how to proceed? Should you pay your credit cards, student loans, or living expenses first? Some basic advice can help you set your priorities.
- pay necessities first
- pay the minimum amount on secured debts next
- work to pay off credit card debt, if you have any
- build an emergency fund
- save for retirement
- start budgeting with the figures right away
- call a spade a spade
- think you can get out of student loan debt
- be afraid to adjust the priorities for retirement
- forget to be flexible
The three big necessities in life are food, clothing and shelter. Necessities do not include things like gourmet dining, a new wardrobe or a small mansion. Pay the necessities first so that you can continue to survive.
A “secured” debt is a loan that is secured by a tangible asset – such as a car or a home. If you do not pay these bills on time, you could lose the asset, which – in the case of a car or home – could be disastrous.
First, start living within your means on a daily basis, and use credit cards sparingly. Depending on your income, you may be able to pay your credit card debt balance debt on your own. Start by choosing either the avalanche or snowball method. And remember that paying off credit card debt is one of the best investments you will ever make.
Determine a fixed monthly amount you can pay toward your debt until all debts have been paid off. This amount should be more than the combined minimum payments on all of your cards. Then choose:
Avalanche—The avalanche method involves paying off debts by starting with the one with the highest interest rate, and working down from there. Make minimum payments on each debt except the one with the highest interest rate. For that, pay the minimum plus any extra you can afford. Repeat this process every month until that debt has been paid off. Then, keep paying the same monthly total – but take every dollar you were using to pay off the highest-interest debt and put that towards paying off the debt with the second-highest interest rate. Keep following this strategy until you’ve cleared away all your debts.
Snowball—The snowball method involves paying off the smallest debt amount first, and working up from there. Pay the minimum on all debts. Then apply any remaining funds from your overall allocated amount toward paying off the debt with the smallest balance. After you pay off that debt, continue paying the same monthly amount you started with. Follow the same strategy as before: Pay the minimum on all debts, but pay all your remaining funds to knock out your second-smallest debt faster.
Start small, and work toward a fund that covers six-nine months of expenses (that means the amount for true necessities, not the salary you’re used to receiving). Even just a few hundred dollars can make the difference between charging and not charging an unexpected expense, and your ability to avoid going into debt. Start socking away any extra cash in a savings account where you can access it if needed, but where you won’t be tempted to spend it otherwise.
Next, save for retirement with an IRA or other plan for your situation.
Before you take pencil to paper, or open a spreadsheet, make a list of your goals. Include your spouse, partner and family as appropriate. What do you want money to do for you? Your goals might include getting out of debt, but list out the reasons why – your ultimate goals. Do you want money to buy a home, send kids to college, take a big vacation, or plan for your retirement? Also write down short-term goals, such as staying on track with all bills, paying for holiday gifts without going into debt, or creating savings to prepare for occasional large expenses like insurance or auto repairs. Let your goals drive your budget, and you’ll find that “budgeting” will no longer be an unhappy word.
Yes, you need to incorporate your debt payments into a budget. But the word “budget” makes some people anxious. Instead, think of it is as a “spending plan.” Write down income and necessary living expenses (which include debt payments). Subtract expenses from income to see if you can make ends meet. If you do not have enough income to pay your necessary bills, you must re-evaluate, as the only answer is to add income or cut costs. If you do have some income remaining after all necessary expenses, decide how you will apply that extra toward meeting your goals.
Student loan debt never goes away. Even in a bankruptcy, it cannot be discharged. Make the required monthly payments on student loans, while putting extra money toward paying down high-interest credit card debt, building an emergency fund, and/or saving for retirement.
While saving retirement comes last in the list above, there may be an exception. If you work for a company that offers a retirement savings plan – a defined contribution plan such as a 401(k) plan or a defined benefit plan such as a pension plan – try hard to contribute to this while paying off debt. These contributions provide tax benefits as well as easy ways to save. If your employer matches any part of your contributions and you don’t take advantage of that, it’s like giving away free money.
Plans, goals, priorities and situations change. Keep a flexible attitude about your financial goals. When income goes up or down, change your spending plan accordingly; pay down debt faster than you planned whenever possible. Revisit your financial goals regularly to be sure they remain in line with your current plans and priorities.
By putting things in perspective and moving one step at a time, you can make decisions that let you set the best priorities and goals for your financial life. Once you cover the basics and get out of debt, you can use money as a tool to achieve longer-term goals. If you can stay out of debt, you can use your money to move forward into an exciting future.