Q: I am paying down several credit cards, as well as two auto loans. I received a bonus recently and thought it might be best used to pay off the collateralized auto loans instead of putting that money into my six-month savings. Please advise.
A visitor, Ft Lauderdale, FL
A: It’s always a good idea to have an emergency fund. Six months is ideal. Three months is good. A year is fantastic, if you have a job or income that would be hard to replace right away if you’re laid off.
So, if you are fairly confident about your employment status, use some of the bonus money to pay down your debt.
But, pay it down in a systematic way.
I typically tell people to get a piece of paper and make a list of all their consumer debt (not including your home).
Put at the top of the list the debt with the lowest balance. So, this is an example of how you would make your list:
- Credit card #1 $1,000
- Credit card #2 $1,500
- Credit card #3 $5,000
- Auto loan #1 $15,000
- Auto loan #2 $28,000
You would concentrate on paying off the credit card with the balance of $1,000, but still make the required minimum payments on the other debts.
Don’t worry about the interest rates. This is a payoff strategy based on emotions, not necessarily math.
Let’s say the $28,000 loan has the highest interest rate, and your bonus is only $5,000. You would make a nice dent in the debt, but not big enough to give you an emotional boost to really make a dash to pay off your other debts.
But, if you took the $5,000 bonus and paid off the first two on the list and part of the third, imagine how that will make you feel? You would feel euphoric.
Based on my experience, you would get so charged up that you would aggressively want to begin to get rid of the rest of the debt.
I call this strategy the “debt dash.” (I talk about it at great length in my upcoming book, The Power to Prosper: 21 Days to Financial Freedom, which comes out in January 2010.)
Now dash off and get those debts paid off.