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The Debt Adviser

Be wise with a windfall

Dear Debt Adviser:
I received a $35,000 settlement and I have $30,000 in credit card bills and $30,000 on a home mortgage. What should I do with the money I received? Collect interest, pay off the smaller credit card bill or invest the money?
Gloria

Dear Gloria:
You are indeed a wise woman. In no part of your question did you ask, "How should I spend the money I received?" You have instead asked what would be the best way to use the $35,000 to your best financial advantage.

It is human nature to immediately think of all the things that you would like to buy with the money. However, without a plan, the money could be gone before you know it and leave you with not much to show for it.

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You and others who receive a financial windfall should consider the following before deciding how to use the money:

  • Determine if the money you have received is considered taxable income. This is important because you will want to make sure to include putting aside some of the money to pay Uncle Sam in April in your plans for the money. No one wants a surprise tax bill!

  • Establish an emergency-savings cushion. Consider bolstering your savings to a level of 3 to 6 months of your monthly expenses. Use an accessible, high-yield, low-risk savings or money market account. The interest will be small, but these savings will help you avoid charging unexpected expenses on a credit card and will help bridge any gaps in employment.

  • Pay off high-interest debt. With the current investment landscape, you will be unlikely to earn more by investing the money than your credit card debt is costing you in interest charges. Pay off the highest interest rate debt first and continue to the next highest until you have paid off all unsecured debt or depleted the money.

  • Review financial goals. You have a golden opportunity to use your windfall to reach some of your financial goals. Whether short-term or long-term, consider putting aside some of the money toward college tuition, retirement or other goals.

  • Give yourself some time if you decide to spend the money. For those who do have an emergency savings account and do not have large amounts of high interest debt, you may wish to spend your windfall. Before you do, make certain you have covered any other financial obligations and give yourself a time frame that you will wait before purchasing anything. My advice is to write down the things that you would like to purchase. Have some fun and create a wish list. Then once you have it all written down take a look at what would be realistic and wait until your prescribed time frame is up. If you still want to spend the money, go ahead.

For your specific situation, Gloria, it may be the best use of your settlement to pay down your $30,000 in credit card debt. At the average annual percentage rate of nearly 14 percent you are potentially spending $4,200 in interest charges per year.

I would encourage you to make sure you have an adequate savings cushion and then begin paying down your debt. Good luck!

The Debt Adviser, Steve Bucci, is the president of Consumer Credit Counseling Service of Southern New England. Visit CCCS for additional debt advice or click here to ask a debt question.

-- Posted: Feb. 14, 2003
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