Financial security is a goal toward which we all strive. If you’re living under the shadow of credit card debt, struggling to make ends meet, or just getting by until an unexpected major expense comes up, you probably spend a significant amount of time worrying about money. You know you need to save for your retirement, and save for emergencies, and pay off your debt—but you can’t do it all at once, so which one should you concentrate on first?
In most cases, your best bet is to focus hardest on paying off your credit card debt. The average credit card interest rate is 16.77%, far higher than any earnings you’d make on savings or investments. As the new information on credit card statements so clearly (and discouragingly) tells you, paying only the minimum means it will probably take you more than 20 years to pay your credit card in full. There’s no sense in keeping thousands of dollars in the bank at less than 1% interest while you’re paying high interest rates on your credit card debt.
First, stop using your credit cards. This should go without saying, but often doesn’t. You will never get out of debt if you keep getting into debt. Next, decrease your 401(k) contributions to the highest amount your company will match—that’s free money, after all. Saving for your retirement is important, but you don’t want to spend your retirement paying off credit card debt. You will increase your contributions when your credit cards are paid off.
Take the money that was going to your 401(k) and set up a small emergency fund of $500-1000. Remember it is an emergency fund—don’t use it for impulse purchases or everyday expenses. Once your emergency fund is set up, take the extra in your paycheck and add it to the minimum payment of the credit card with the highest interest rate. Pay this amount every month until the card is paid in full.
When you have eliminated that debt, take the amount you were paying on the first card and add it to the minimum monthly payment for the card with the next highest interest rate. Pay that amount every month until the second card is paid off, and then move on to the next one, and so on. This method, called “snowballing” your payments, will chop years and thousands of dollars off of your debt repayment.
After you have paid all off your credit cards, change your 401(k) contributions and put in the maximum amount allowed by your plan. Take whatever is left from your old credit card payment amount and add it to your emergency fund until you’ve got at least 8 months of expenses saved. This plan will take a few years, in most cases, but at the end you’ll be free of credit card debt, fully funding your 401(k), and you’ll have a healthy savings account for emergencies.
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