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What debt should I pay off first?

I recently accepted a job that’s 15k less than my previous job. Unfortunately now I’m living pay check to pay check. I need a solution to pay off my debt but at the same time I need to loose up some money so I can live. 20k in Savings I get another 15k in March 2014. What should I pay off asap.

Debt: Credit Card 1: 6200 10.9% Credit Card 2: 9671 0% until Dec 2015 Credit Card 3: 10883.15 8.9% Car 1: 18310.00 Payment 339.00 Car 2: 47500 3.42% Payment 1070.00

Which optional should I choose? Optionl 1. Payoff Credit card 1 and 3. Then pay off credit card 2 when I get my taxes: At the most saving me an extra 500 dollars a month. Option 2. Payoff Credit card 1 and put 10k on my car and refinance at 35K: Then pay off credit card 2 when I get my taxes: This will save me at least 650 a month. Option 3. Pay off credit cards 1 and 3. Will save me 300 dollars a month Option 4. Put 10k on car 2 and refinance at 35K: and pay off credit card 3 save me 750.00 a month. Choose an optional or provide me a better option.

Dec 07, 2013 by robert from Holland Point, MD  |  Flag
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3 votes

Robert,

I think you have to realize that having a new job paying $15,000 less a year will reduce your monthly cash flow by aprox. $900 in after tax spending dollars. So you will have to also make some lifestyle adjustments or get a n additional part-time job.

  1. Using the $20,000 of cash you have; payoff credit card #1 owes $6200 at 10.9% and cut up the card! Also pay down credit card #3 by $6,000 , The $8,000 of extra cash is your emergency funds.
  2. In March of 2014 you will get $15,000: payoff remaining credit card #3 $5k at 8.9% and cut card up. Use this $10,000 to convert your credit card habits to cash payments and reduce credit card #2 charging 0% interest with monthly payments that will eliminate the balance in 12/15.
  3. I would sell the $47,000 car and get rid of a $1070 monthly payment. You can get a new leased Maibiu or Fusion for $200 a month. You need good wheels and miles to get around not luxury. Check this out you will save big $$$!

If you have a 401-k plan, you can get a loan of 50% up to $50,000 and payoff your other car debt of $18k. Then the only payment you will have is to the 401-k loan over five years and your will be paying yourself off. It is very easy to spend money and get in to debt, while it is very hard to pay it off, especially in a challenging economy like we have. Work hard, save money, don't spend on wants only needs and think cheap!!

Good luck!

Comment   |  Flag   |  Dec 08, 2013 from Milwaukee, WI

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2 votes

Robert,

As a general rule you want to pay down your debt with the highest interest rate first and then the 2nd highest, etc. This will save you the most interest cost over the term of all debt combined.

When you explain how much you will save per month in your various scenarios you are including principal (loan) repayment with your interest cost. This can be deceiving. For example, your minimum payment on your 0% credit card 2 could be $1,000 a month (I know it isn’t) but paying it off will not save you $1,000 per month in interest. The payment will reduce your debt by $1,000 and avoid no interest expense. Conversely your credit card 1 is costing you $675 this year interest so after paying $1,000 against card 1 for six+ months you will avoid the credit card 1 balance growing at $675 due to interest. Your goal is to come up with a pay down plan that avoids the most in future interest.

You should pay off the car loans last due to their low interest rate. You have to be careful with a refinance because although you are reducing you monthly payment it is only because you are spreading your payments out over more months than you have remaining on the current term. So a refinance of the auto loans will mean paying more in interest on the new loans than you would pay over the remaining term of the current loans. I’m assuming you would refinance at the same loan rate.

So you will be better off over the long term if you pay down credit card 1, followed by 3 followed by 2 (safe to say in Dec the interest rate on card 2 will be higher than the auto loans).

Paying off the cards and leaving the car loans will leave you with about $10k for emergencies without having to go back to credit cards. If this strategy doesn’t reduce your monthly cash out to your cash in you should try very hard to reduce discretionary household expenses such as gifts, travel, eating out, etc. until your cash in/out are equal, or better yet, you can save and invest for retirement. Note that if you reach the point, through expense reduction or future salary increase, that you have positive cash flow I suggest investing for the long term instead of paying off the car loans as odds are over many years you will make more on your investments than the 3.42% you will avoid by paying down the auto loans. If you have a 401(k) plan at your new employment that would be the first place to consider saving for retirement as you will reduce your taxable income and you may receive a matching contribution from your employer.

Comment   |  Flag   |  Dec 07, 2013 from Woodbridge, VA

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2 votes
Rich Winer Level 20

Robert, In addition to John's recommendation, I would get rid of your credit cards and start using a debit card. That will force you to spend only what you have in the bank. I would not consider owning a credit card until you have paid off all of your credit card debt. With credit cards, it's too easy to spend what you don't have and buy things you can't afford. Hope this advice helps.

View all 4 Comments   |  Flag   |  Dec 08, 2013 from Woodland Hills, CA
James D. Kinney, CFP™

I just wanted to point out that it is important to maintain some source of emergency funds. I had my own ideas expressed below, but paying off debt using all available savings is risky unless there is some source of readily available funds for crisis. That could be credit cards - but risky since cards may be cancelled or credit lines cut once they are paid off. Could be home equity line of credit, but don't know if he has one. That is why I would consider, if circumstances permit, replacing the cars as the first choice. You may be able to reduce monthly payments without using any available emergency funds at all. But if cars are brand new the loans may be higher than vehicle value. Then gradually pay off the cars while leaving some cash in place for emergencies. Robert summed up my thinking well below I think.

Flag |  Dec 09, 2013 near Bridgewater, NJ
Rich Winer

Good points. I just know that some people are addicted to credit and Robert does have $18,000 in debt spread over three cards. That seems like a bit of a red flag. Ideally, he should probably work with a local financial advisor who can guide him and monitor his progress on an ongoing basis. I always hesitate to provide too specific a recommendation in this forum because financial planning is a personal process that really needs face to face interaction and an ongoing relationship.

Flag |  Dec 09, 2013 near Woodland Hills, CA

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1 vote

Be very careful how you tread here. If you use all savings to pay debt, you have no emergency reserve fund. You may be able to fall back on credit cards...but if your credit score has been damaged, there is no guarantee the card companies will leave your credit limits intact. I agree with the idea that you do the high interest cards first. Also, "refinancing" car loans is an uncertain proposition at best. If your cars are worth more than the loans, I would suggest trading in the cars and getting much cheaper models. The loan balances suggest you have much more auto than you can now afford. This would give you smaller car loans, leaving the emergency funds largely in place, then you pay down the credit cards with your tax refund.

Comment   |  Flag   |  Dec 09, 2013 from Bridgewater, NJ

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Congratulations on recognizing your challenges and having the interest to tackle them. However, more drastic action is necessary than the options you outlined above. Here comes the tough love. Your statement that "now I'm living paycheck to paycheck..." implies you were living within your means and saving when your salary was $15,000 higher. But over $26,750 in credit card debt indicates you were still living above your means. Your income is down $1,250 a month before taxes, so saving $500 to $750 from any of the credit card options above will not be enough.

First, see if you can switch credit cards 1 and 3 to 0% accounts for some short-term relief.

You didn't provide any details on the year, make and model of either car but $1,409 a month in car payments is strangling you, especially the $47,500 car loan with the $1,070 monthly payment. The reality may be that you replace car 2 with a less expensive model and a lower monthly payment.

Work on reducing the car payments as much as possible, and then address the credit card balances. The general principle is to pay off the highest interest rate card first, then the 0% card with the least amount of time remaining at 0% interest. You can use some of your $20,000 cash balance and $15,000 coming in March 2014 to pay down credit card debt, but be sure to keep some cash cushion as an emergency fund so that you don't end up running up your credit cards again. Bottom line, you need to reduce your current expenses much more than just eliminating the credit card and car loan payments.

You need to take a hard look at your lifestyle and your spending. Do you really need a $50,000 car? You need to trim certain luxuries from your budget so that you can get back on track. You should give serious consideration to no longer using credit cards. Instead, use cash, checks and debit cards to stay within your means. Don't worry about sacrificing credit cards rewards because your total spending is the culprit. A good financial planner can sit down with you and look at your entire financial situation, offering more specific advice on what you can do to put your debt behind you and get started building wealth. I'd encourage you to make an appointment with someone today!

Comment   |  Flag   |  Dec 26, 2013 from Township of Anderson, OH

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