a raise? Start an emergency fund
I recently received a modest increase in my salary and want to use
the amount remaining after taxes and a 401(k)-percentage contribution
to pay down debt. Should I use these funds to pay down a substantial
credit card balance with a moderate interest rate, or should I add
principal payments to my fixed, low-interest mortgage loan, which
has 26 years left on it to pay? Thanks.
Congratulations on the raise, and what a smart,
sensible person you are!
I guess the knee-jerk reaction to your question would
be to recommend that you pay down your credit card debt first, if
only because you have a "moderate" interest rate on the
credit cards as opposed to a "low" interest rate on your
mortgage loan. There is also the fact that your mortgage interest
might be tax-deductible whereas your credit card interest is not.
You could split it and use half of the raise on each debt. From
a purely dollars-and-cents standpoint, paying down high-interest
debt first gets you out of debt the fastest. But both ideas have
merit and would benefit you.
However, there are two other options you might consider.
I see that you are a regular contributor to your company
401(k) plan. But do you also have an emergency savings account in
place? If not, this is an excellent time to start one using a portion
of your new raise to get started. You might use half to put toward
your credit card debt and put the rest in a savings account to use
Although your contribution to an emergency fund might
be small to start, if you have read my column very often, you know
that I believe an emergency savings account is one of the best ways
to stay out of debt trouble. I also advocate saving "new"
money, such as raises and bonuses, which is what you would be doing
here. Saving at least half of new money is fairly painless, since
you never get used to having the extra amount at your immediate
While getting out of debt as soon as you can is important,
getting into the habit of saving might be more so for your future.
An emergency savings account will be there when your car breaks
down or your washing machine dies. These life events are bound to
happen one way or another, but having that savings will certainly
cushion your financial life. Six months' living expenses is what
you should shoot for in a readily accessible, liquid account.
If I'm preaching to the choir and you already have
adequate emergency savings, double kudos to you on your sensible
nature. My last thought is to consider the relative value of paying
down your mortgage versus adding to your long-term investment account.
You are on the right track to becoming debt free. Other people would
do well to follow your example.
Debt Adviser, Steve Bucci, is the president of Money Management International
Financial Education Foundation and the author of Credit
Repair Kit for Dummies. Visit MMI
for additional debt advice or to ask a question of the Debt Adviser go to the "Ask the Experts", page
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