A common question we get at Wealthjar is whether to use excess income to pay down your debt faster or start investing for your future. The answer depends on each individual’s unique circumstances, but there are certain steps everyone can take to start moving in the right direction. A common question we get at Wealthjar is whether to use excess income to pay down your debt faster or start investing for your future. The answer depends on each individual’s unique circumstances, but there are certain steps everyone can take to start moving in the right direction.
1. Get to know your cash flow
In entrepreneurial terms, determining your cash flow is like analyzing your business’ balance sheet. Instead of comparing assets to liabilities, however, you are analyzing your income and expenses to determine your overall financial health. Here, we’re assuming that you’re factoring your minimum debt payments into your net monthly cash flow.
It’s crucial to make these minimum monthly debt payments on time before starting to build a safety net or save up for your next mini-retirement. Missing your minimum debt payments could damage your credit score, end up costing you more in the long run, and make it much harder for you to borrow money in the future.
If you’re reading this article, chances are you have a positive cash flow after paying off your mandatory bills and expenses.
2. Get to know your debt
The most common types of high cost debt are:
- Student debt
- Credit card debt
When deciding whether to pay down your student loans faster or start investing sooner, you should first familiarize yourself with the varying interest rates and possible tax benefits of carrying student debt. It’s important to understand that not all debt is created equal: know the interest rate of your loans and see if you qualify for any tax benefits .
If you’re like the many Americans that borrowed money from the federal government during undergraduate or graduate school, it’s likely that you took out a combination of subsidized and unsubsidized loans. Unsubsidized loans should be paid off first since interest rates on these loans are generally much higher. The federal government is helping you foot the bill on your subsidized loans, so paying the monthly minimum may be sufficient to avoid accruing interest. If you took out private student loans to help pay for college, take a look at the interest you are paying and compare it to the current market rate of interest.
If you borrowed during a period when interest rates were relatively high, you may benefit from refinancing your loans. As always, each individual’s circumstances are unique, and it is important to talk to a financial advisor to make sure you’re on the best path toward paying down these loans.
Credit Card debt
Credit card debt is often the most expensive type of debt carried by Americans with rates that reach heights of 15%. It is important that you pay off your balance each month so this high rate of interest doesn’t have a chance to accrue. If you’re having trouble keeping up with your minimum payments, try reaching out to creditors to come up with a payment plan you can manage. You might be surprised to learn that many creditors are willing to work with you to come up with a plan you can afford.
3. Pay down high cost debt first
Once you know how much your debt is costing you, prioritize paying off your high cost debt. At Wealthjar, we consider an interest rate over 5% to be “high cost”. Even though the market has historically given investors a return over 5%, these returns can fluctuate, and it is hard to beat the guaranteed savings of 5% that you can achieve by paying off this type of debt before the interest accrues.
4. Start Saving
While you’re paying off this high cost debt, it is important to put any extra funds in a “safety net” account. A safety net is generally considered to be three to six months of your living expenses. This account can help you get through any unexpected expenses or a temporary loss of income without damaging your credit or defaulting on your monthly bills.
Living expenses include housing, monthly bills, mandatory debt payments, and all the basics. For example, if you spend $1500/month on rent, $500/month on food and $300/ month on gas, ultilities, and $1000/month for your car payment and student loan payment, your ideal safety net would have from $9,900-$19,800 at any given time.
5. Put your money to work
Once you have these essentials covered, it may be time to put your money to work in an investment account. It’s easy to get started: Just fill out our online contact form then your Wealthjar financial advisor will be in touch shortly.
 Certain tax benefits are available for qualifying individuals such as the Student Loan Interest Deduction: “if your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return), there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education.” https://www.irs.gov/uac/tax-benefits-for-education-information-center