Monday, December 27, 2010

Holiday Hangover: Part II

The Next Step

Now that you know how much is coming in and how much is going out, come up with a plan to pay down your debt as quickly as possible and prepare yourself for the future.

Make saving a priority

First, pay yourself! Put money into a savings account out of each pay. Most employers will allow you to deduct an amount from your paycheck to one or more financial institutions. If you are a member of the credit union, we can split your payroll in whatever way you choose once it gets here. To avoid the holiday hangover next year, you might want to set up a Holiday Club account now and put a few bucks in that as well.

Eat out less often, buy fewer cups of Starbucks, pack your lunch, or whatever it takes to at least start on your savings

Many financial planners recommend that you have 3 to 6 months of your income in savings to weather a crisis involving medical leave or loss of a job. For many people, especially younger ones, that’s simply not realistic….but you have to start somewhere. Put money aside in a savings account and forget about it. If you can save 10% of your pay, you’ll find that nest egg growing quickly. Once you establish your emergency fund, begin saving toward longer term goals, such as buying a home or retirement savings.

Look for new ways to pay down debt

Now it's time to wrap your head around that ugly debt. The way that works best for me is to start with the highest interest debt and put as much extra as I can toward that debt, while making the minimum payments on the other bills. When the highest rate bill is paid off, I take the amount of the payment I was making on that bill and pay it all on my next highest rate debt. Some people call this "snowballing" your debt.

You may want to pay on your loans more frequently than once a month. If you get paid weekly, you might want to take the monthly payment, divide it by 4 and pay that amount every week. It's easy to set up an automatic transfer from your checking account or just transfer the money online every week. Why, you ask? Because by paying more frequently, you are reducing the principal amount faster, and will pay less interest in the long run. 

For example: suppose you owe $5,000 on an 11.99% APR credit card. If you make monthly payments to pay it off in two years, the payment will be $235.36 per month and you will have paid $848.59 in interest over that time.

Taking that same debt and dividing the monthly payment into 4 weekly payments, you will pay $58.84 per week and the debt will be paid off in 95 weeks (or about 22 months) and you will only have paid $569.63 in interest. You will be out of debt 2 months earlier and have saved almost $300.

Dividing your payment to coincide with your paychecks can make managing what's left a lot easier too. 

By taking control of your finances, you will find it’s easier to stay out of debt, keep your credit rating in good standing, save for the future and your overall sense of well-being will improve. 

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