You work hard for your money. This article gives you three ways you can keep more of it, and comes from the office of noted Philadelphia bankruptcy attorney David M. Offen.
Tip #1: Pay Off Your Credit Cards in Full Each Month
Paying interest on credit card debt is a waste of hard-earned money, pure and simple. With interest rates ranging from 12% to 24% and more, revolving balances skyrocket quickly. Even paying just the minimum monthly payment can quickly become unaffordable if you continue to charge purchases and not pay them off in full.
The best way to use credit cards is first, to obtain cards with some sort of rewards program such as cash-back or points. Second, use your credit cards for anything you would typically use cash for, such as groceries or gas. Last, be sure to pay the balance off in full each month. This way you are establishing a good credit history and keeping your debt-to-income ratio low.
The problem arises when interest is applied to any balance revolving into the following month or months. Let’s use an example so you can see how dire the situation can become with maintaining a credit card balance.
Let’s say your car breaks down on the highway. You need a car to get to work, so it must be repaired. You have it towed to your trustworthy mechanic who tells you you’ve blown the head gasket, the engine overheated and seized, and there is nothing to be done but to drop a new engine in, to the tune of $5875 with parts and labor.
After you recover from the shock, you consider your options. Buying a new or a new-used car is not really an option for you right now, yet you don’t have $5875 lying around. You give the mechanic your credit card and he promises to have your car repaired for you in a week. You rent a car for a week for $375 and hope for the best.
Your credit card carries 16% interest. The minimum monthly payment on this debt is $250, and if you make that payment every month it will take you 31 months to pay this debt off. When it is paid off, you will have paid your credit card lender $1,291 in interest.
That’s $1,291 down the toilet, with the only benefit to you being that you had ready access to that money when you needed it.
What if you are not fortunate enough to have a credit card carrying 16% interest? Many people have a much higher interest rate, such as 22% or more. At 22%, your monthly minimum payment is still $250 but it will take you 34 months to pay it off and you will have paid $2005 in interest!
Now here’s the kicker. What happens if another financial emergency arises during those 31 or 34 months while you are paying off the car repair debt? You’ll have to charge it and pay it off, and so on, and so on. In the meantime, your credit score is in the toilet because your debt-to-income ratio is high, making it more expensive to take out a car loan or a mortgage.
There is a way to protect and improve your credit and avoid wasting money paying credit card interest.
Tip #2: Start an Emergency Fund
Use your own money for emergencies. Start saving now.
Let’s say you’ve already been saving $250 each month and have been doing so for almost two years now. Your car breaks down, your mechanic presents you with the same bill as in the previous example. You weigh your options:
#1 You have $5,802.77 saved and could pay for the repair outright.
#2 You have established a good credit history by paying off your credit card balances in full each month and keeping your debt-to-income ratio low. Since you have excellent credit, you will be offered a car loan at a very favorable rate of interest. Instead of repairing the car you have, you can consider buying a new car and using your emergency savings as a down payment.
Having ready cash in a savings account earning interest for you has put you in a much better financial position to deal with this so-called emergency, which is really just a life event that you deal with easily because you’ve prepared for it. Once the emergency is over and your car is fixed or you’ve purchased a new one, you simply start saving again.
What About the Emotional Toll Debt Takes on you?
Debt is a burden both financially and emotionally. You might not think you feel that way, but when you have no debt take stock of how you feel. Don’t you feel lighter? Perhaps you feel more optimistic, knowing that you are working to earn money for yourself and your family, not the stockholders of some credit card company.
Now, think about how you will feel when you have no revolving credit card debt and a tidy emergency fund saved up. You will feel not only lighter and optimistic but more secure and confident knowing you are prepared for the unexpected.
Perpetually dealing with credit card debt and having no emergency fund creates issues far beyond finances. It impairs your quality of life.
Tip #3: Take Advantage of Pre-Tax Savings and Investment Accounts
You’ve started a new job and in your onboarding meeting with HR, you are told that you have the opportunity to contribute to your employer’s 401(k) or 403(b). Should you do it? After all, you may be just starting out and not making much money.
The answer is unequivocally yes. You absolutely must save for retirement, because there is no guarantee that Social Security will be sufficient to fund your retirement lifestyle, even if the program does still exist by that time.
But there are even more compelling financial reasons to contributor to your employer’s pension plan. First, you contribute with pre-tax dollars. This means your taxable income decreases by the amount you contribute, placing you in a lower tax bracket. You pay less income tax on your money.
Second, when you withdraw those funds in retirement, presumably you will be in a lower tax bracket then and again, you will pay less income tax on that.
Third, pension plans often offer opportunities to borrow from your account before retirement for things such as a down payment on a home or education. Ask HR what opportunities are available for you in the future.
Last, many employers offer to match your contributions to your account. If you do not contribute at least the amount your employer matches, you are leaving free money on the table!