Too often people find themselves in trouble with their finances. Too much debt with not enough saved for retirement. Not knowing how to change. They want to pay off debt but struggle with where to start.
How do you decide what to do first?
Many people think that the first place they should focus their energies on is paying down their debt, specifically credit card debt. On the surface this looks like the most logical place to start. Afterall, you are paying hefty interest rates (18% up to more than 30% APY if you have missed payments) on top of the amount that you actually owe and everyone knows that debts are a huge negative when you are trying to plan for your financial future.
So that’s where you should put any “extra” money, right?
Not so fast!
Let’s take a look at another option.
Paying Down Debt First
Imagine for a minute that you have looked at your monthly expenses, have “found” an extra $400 each month (need some ideas where you can find “extra” money?? — check out our free ebook HERE) and put all of that money towards paying down your credit card debt.
Month after month you put that $400 towards your balance and you watch the “amount due” decrease steadily. You feel good. You are making progress and your debt is decreasing. Goal accomplished, right?
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But Wait! What happens when “life happens”? The car breaks down, you suddenly need a new hot water heater, your dog needs emergency vet care, or any of the million things that can (and do) happen unexpectedly.
Without planning for these occurrences, without having an emergency fund, you end up pulling out a credit card. And the debt that you so proudly just paid down has now increased. And you feel stuck.
You are in a negative debt spiral with no way out.
Instead, let’s picture a different scenario.
Funding Your Emergency Fund
But shouldn’t I worry about that AFTER I pay off my debt?? Let’s take a look.
Taking that same $400 that you “found”, designate part of it towards an emergency fund and then use the remaining funds to pay down the credit card debt. Continue doing this month after month, slowly building up your emergency fund, while still paying down your debt balance, although a little slower than if you put the entire $400 towards debt.
What happens NOW when “life happens”?
It changes your habit of reaching for the credit card.
Someone smashes into your car and you have to pay your deductible to get it repaired…
Instead of reaching for your credit card to pay for it, knowing you will spend the next several months (if not more) paying it off, you can confidently pay for it out of your emergency fund.
NOW you have broken out of the negative spiral and can make true progress towards your financial goals!
So while it might seem logical to tackle the debt that is costing you money, stashing some cash away to cover those unexpected “surprises” in life will actually get you much further along the path of financial freedom than paying every extra dollar towards reducing your debt.