Living salary-to-pay check has a major impact on your financial choices. You may experience high credit on your credit card, but you cannot pay off the debt, or you can save for school or retirement, but hardly pay your monthly bills. However, if you launch a new job that pays well or receives an additional source of income, the extra money can provide enough disposable income to pay off your debt or start saving. But what do you do first?
Opinions vary among financial experts, and both approaches have advantages. Consider the different reasons for both methods to find out which ones work best for you.
Reasons to pay off the debt first
Nobody likes debts, and without the right level of income a high balance can follow you jareLemminkäinenang. But if you have the money, here are three good reasons to pay off your debts before saving your money.
1. Eliminate investment interest
The majority of credit card holders pay interest on a monthly basis, which can be more than 20%. High rates make it difficult to pay your credit card debt, especially if you get into a rut that you only pay your monthly minimum. This is because a large part of your minimum payments is applied to the interest costs, and not to the principal.
Suppose you have a credit card with an interest rate of 22%. If your credit card balance is $ 5,000 and you pay the monthly minimum of $ 141 per month, it will take 281 months to pay the balance. You end up paying more than $ 8,000 in interest payments alone in almost 24 years.
However, if you receive an additional $ 500 each month and pay this in cash to your debt, you can cancel the same balance in about one year and you only pay around $ 541 in interest – a saving of nearly $ 7,500.
2. To improve your credit score
If you try to improve your credit score to qualify for a mortgage or car loan, paying off your debt can get your plans off to a flying start.
Credit card and credit balance factor in your FICO credit score – in fact, the amount you owe is no less than 30% of your score. Your saving history at your bank does not take credit scores into account, but if you want to prove your creditworthiness by adding points to your score in a relatively short time, paying your balance is the right choice. Once you improve your credit score, you are eligible for lower interest rates on car loans, mortgages and other types of loans.
3. To achieve peace of mind
If you owe hundreds or thousands of dollars in credit card debt, it is likely Lemminkäinenijk that you know the fear it can bring. The thought of earning thousands of dollars in addition to your debts can turn your stomach around. If you seek relief from this stress, settling your credit card debt as quickly as possible is the best course of action. In addition, while you may want to save money, you may end up deeper in debt if your interest rates are high.
Reasons to start saving first
Wouldn’t it be nice to see your savings or investment accounts grow month after month? If you focus on saving money before paying off your debts, you can realize this dream sooner.
1. You have a low interest rate on your credit card
If the return on your savings account is more than what you pay each month in credit card interest, saving before eliminating debts makes financial sense.
Suppose you have a low credit card debt and a low interest rate on your credit card. You can pay your credit card bill over time and spend your extra money on savings. However, this approach does not benefit everyone. It is important to carefully read the terms of your credit card agreement.
For example, a 0% interest rate on a credit card is often limited to the first 6 to 12 months after you open an account. But after the introduction period has passed, the interest on the card can rise to well above 20%. If you decide to save before paying off your debts while taking advantage of a 0% interest credit card, talk to the issuer and inquire about the average interest rate as soon as the initial interest period ends. It is crucial to keep the rate low to avoid high interest costs in the long term.
If you cannot pay the balance on your credit card before the 0% introductory period has expired, but you have achieved a high return on your savings account, you can use money from your savings account to pay your remaining balance and then top up your account.
2. Make a financial cushion
While paying off debts first helps to achieve your credit score and offers peace of mind, it does not help during a financial crisis. If you spend all your money repaying debts, you will not have saved anything for a rainy day. Create a six to eight month emergency fund that can help you with loss of work, divorce or illness. It also prevents you from going deeper into debt when dealing with an emergency.
Deciding whether you should pay off your debts or first create a savings account is entirely up to you. Evaluate your personal financial goals and decide which is more important.
If you can’t make a decision, why not enjoy the best of both worlds? Take your monthly disposable income and share the money evenly between your debt and your savings. It takes longer to pay your balance on your credit card and your savings will grow at a slower pace. Ultimately, however, you achieve your financial goals – and once your debts are gone, all your extra income can go to savings.
Which option – saving money or paying off debts first – do you think that’s best?
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