Budgeting, Part 3: Paying Down Debt
Eileen St. Pierre, The Everyday Financial Planner
With tax refund checks starting to arrive, now is a good time for the final installment in my Budgeting series focusing on paying down debt. The 30-40-30 plan is a popular plan for using your tax refund. Use 30% to pay off past debts and catch up on bills. Devote 40% to current spending like replacing the dishwasher and putting new tires on the car to avoid adding new debt. Then use the final 30% to build your emergency savings so you do not have to take out more debt in the future if unforeseen events happen.
But if you still find yourself with too much debt, here are some additional tips:
Pay off your lowest balance debt first.
This advice is counter to what many financial counselors tell you. Many say to pay off your debt with the highest interest rate first. But having a lot of debt can be depressing. By paying off your lowest balance first, you get a sense of accomplishment and realize “Yeah, I can do this!”
- Don’t forget about your other debts. Make the minimum payments on those.
- Once you get rid of that small debt, then you can concentrate on the one with the highest interest rate.
Make power payments.
Once you pay off your lowest balance, take the money you put towards that debt and start putting a larger amount towards your next debt in your list to pay off. After all, you were already used to devoting your budget to this.
PowerPay is a great website to help you do this. It was created by Utah State Extension and is free to use. You just need to register (name and email) to use it. You can set up your own debt elimination plan.
- It can show you how much you can save in interest costs by making power payments.
- You can also set up a spending plan – it provides benchmarks in each of the spending categories so you can determine what budget areas you need to focus on.
- As debt is eliminated, it now becomes possible to start saving and investing. You can use the PowerSave option to help you set up a savings plan.
Follow my Six Steps to Reducing Debt.
It takes longer to get out of debt than it did to get in trouble in the first place. Once you accept this, following these steps to become debt free will instill in you the financial discipline to (hopefully) keep this from happening again!