Start an emergency fund while paying debt

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Dear Debt Adviser,
I have a high debt ratio compared to my income. My debt is about $80,000 and is mostly credit cards. My income is about $85,000 a year. Each month, I pay the minimums due and a mortgage payment of about $1,300, and I have about $1,500 left over. If I follow the plan I created by cutting in some places, not charging any more on the credit cards and paying more than the minimums due, I would be debt-free within three and a half years. But I would be broke each month without any cash available. Please advise on what I should do. Thanks very much.
— Dan

Dear Dan,
I am delighted to hear that you have a spending plan in place that will allow you to get out from under your mountain of debt in less than four years. Just don’t mistake your plan for reality. By all means, follow the plan you have created to pay off debt. You may be “broke” for the time it takes to pay your very high credit card balances, but you will be taking the essential and necessary steps to secure your financial future. The reality I want you to be ready for is that life happens when you least expect it, can least afford it and in unexpected ways. And sometimes what life throws at us involves the loss of income and/or large unexpected expenses that can cause difficulties in making payments on a large debt load.

One adjustment I’d like you to consider in your payoff plan is to allocate some of your $1,500 surplus money to be put aside in an emergency fund if you don’t already have money in a savings account. With $80,000 in debt, it’s likely that you don’t. It is important to balance paying off your debt and putting aside money to avoid having to add to your debt with unplanned-for expenses. Because your plan is to take more than three years to pay off the debt, the chances of a change in income or some unexpected expense cropping up in that time are pretty good. My advice is to try to set aside at least six months’ of minimum payments in your emergency fund. My guess is that your minimum payment is around $2,000. Building a reserve of $12,000 will lengthen your payback time by about eight months, but it will allow for some unexpected life events while still completing your payback.

A second suggestion I have is to develop a plan for moving forward after you have paid off your credit card debt. A goal of becoming debt-free is a good motivator. As your debt drops, so will your motivation unless you have an incentive to finish your plan. Think of the great fun things you can do with the money you’ll no longer be paying the credit card company and list them in a place you check frequently. This will help keep you on track in the tough times.

Lastly, I’m not sure how you ended up with $80,000 in credit card debt but I would recommend that you spend some time figuring out how it happened so this doesn’t become a recurring nightmare.

If you need help setting some financial goals, I suggest that you visit with a Certified Financial Planner. They should be able to help you begin the planning process and offer you some coaching as you move along. Remember, life’s surprises are not always negative. Having a relationship with a CFP will help you take advantage of any opportunities or windfalls that may come your way.

Should life throw you a major curveball and you find yourself not being able to make at least minimum payments on your debt, seek help early. Don’t wait until you are 60 or 90 days late and your credit has tanked. Getting help early will give you every opportunity to come up with a workable solution to the problem.

Good luck!

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