What to do with some unexpected money?
January 22, 2011 4:40 PM Subscribe
What to do with some unexpected money?
We recently received $5000 somewhat unexpectedly. We have debt in a sum larger than this amount spread over credit cards, cars, and another loan. Which course of action is recommended?
a. Pay down credit card with highest balance/interest, which will presumably lower monthly payments.
b. Pay off car payment and/or loan so that car/loan payments can be applied to credit card debt.
I feel like a is the "right" answer, but I think I should call to see how much the monthly payment would actually be reduced to.
Basically, if my current card payment is $250 a month and my current car payment is $300 a month, does it make sense to reduce the card payment or does it make more sense to remove the car payment completely so I can use that money towards paying down the card faster?
Does this make sense or am I confusing myself?
We recently received $5000 somewhat unexpectedly. We have debt in a sum larger than this amount spread over credit cards, cars, and another loan. Which course of action is recommended?
a. Pay down credit card with highest balance/interest, which will presumably lower monthly payments.
b. Pay off car payment and/or loan so that car/loan payments can be applied to credit card debt.
I feel like a is the "right" answer, but I think I should call to see how much the monthly payment would actually be reduced to.
Basically, if my current card payment is $250 a month and my current car payment is $300 a month, does it make sense to reduce the card payment or does it make more sense to remove the car payment completely so I can use that money towards paying down the card faster?
Does this make sense or am I confusing myself?
The first rule to getting out of debt is to always pay off the highest interest debt first. The size of the debt doesn't matter. Congrats on the unexpected money :)
posted by eisenkr at 4:46 PM on January 22, 2011
posted by eisenkr at 4:46 PM on January 22, 2011
The smart move is always to pay down the highest interest loan first, unless your car is about to get repossessed (and even then, it's a maybe).
posted by auto-correct at 4:46 PM on January 22, 2011
posted by auto-correct at 4:46 PM on January 22, 2011
I don't know what your highest interest credit card is charging you, but let's say 20%.
Imagine if you could put that $5000 in a savings account and get a guaranteed 20% interest rate. That would be an *insanely* great deal, and essentially you have access to that deal. (Well, you're not really earning 20%, but you're avoiding losing 20%, which is good enough!) Pay off your highest interest rate accounts.
Note: This will lower your minimum payment on that card. Ignore that. Continue to pay $250 a month. Or more, if you can afford it. Every extra dollar above the minimum earns that magical 20% interest.
posted by IvyMike at 4:52 PM on January 22, 2011 [5 favorites]
Imagine if you could put that $5000 in a savings account and get a guaranteed 20% interest rate. That would be an *insanely* great deal, and essentially you have access to that deal. (Well, you're not really earning 20%, but you're avoiding losing 20%, which is good enough!) Pay off your highest interest rate accounts.
Note: This will lower your minimum payment on that card. Ignore that. Continue to pay $250 a month. Or more, if you can afford it. Every extra dollar above the minimum earns that magical 20% interest.
posted by IvyMike at 4:52 PM on January 22, 2011 [5 favorites]
Pay off the credit card first -- but, if that doesn't pay off all your outstanding balance, do NOT start paying less on the credit card per month. Keep paying as much as you reasonably can, regardless of the minimum payment, until they're at zero balance. Then keep them there.
posted by brainmouse at 4:52 PM on January 22, 2011 [1 favorite]
posted by brainmouse at 4:52 PM on January 22, 2011 [1 favorite]
The only caveat I'd make to the excellent advice above is if you're in substantial danger of not being able to make payments at all in the near future, pay off the car - the credit card companies won't repo your transportation. But otherwise, yeah, highest interest first.
posted by restless_nomad at 5:06 PM on January 22, 2011 [1 favorite]
posted by restless_nomad at 5:06 PM on January 22, 2011 [1 favorite]
Option (b) is Dave Ramsey's "debt snowball" method, which might have some psychological logic to it, but it's often not the best option if interest rates differ. Paying off that car would give you an extra $300/month, true, but it would take 16 months for that extra monthly amount to add up to the $5000 you have now. Meanwhile, you would be paying double (?) the interest on that $5000 because it's on a credit card instead of a car loan -- maybe somewhere in the neighborhood of an $800 difference (??).
The one thing to consider is your car insurance payment. If you own the car itself, you don't have to carry full insurance, just enough to protect others' cars. If you don't need a car and could survive having the car be totaled without being able to immediately buy a new one, thenyou should just sell it you could drop that higher coverage after you owned the car outright.
Carrying only the minimum for awhile would give you another extra amount every month. If the insurance savings were huge, they could counter-balance or outweigh the higher credit card interest, making it smarter to pay off your car. But the risk of crashing your car and not being covered for that loss is worth taking seriously.
posted by salvia at 5:17 PM on January 22, 2011 [1 favorite]
The one thing to consider is your car insurance payment. If you own the car itself, you don't have to carry full insurance, just enough to protect others' cars. If you don't need a car and could survive having the car be totaled without being able to immediately buy a new one, then
Carrying only the minimum for awhile would give you another extra amount every month. If the insurance savings were huge, they could counter-balance or outweigh the higher credit card interest, making it smarter to pay off your car. But the risk of crashing your car and not being covered for that loss is worth taking seriously.
posted by salvia at 5:17 PM on January 22, 2011 [1 favorite]
geoff. You always want to pay off the highest interest debt first.
This is not correct.
Yes, it makes the most sense mathematically to pay off your high-interest debt first. If you pay off your debt from highest interest rate to lowest interest rate, you'll pay less in the long run.
However, there are a couple of problem with that method:
In short, don't let anyone try to tell you there's just one way to do this. There's not. Go with what feels best for you and your situation. But please do use that $5,000 to pay down debt.
posted by jdroth at 5:42 PM on January 22, 2011 [5 favorites]
This is not correct.
Yes, it makes the most sense mathematically to pay off your high-interest debt first. If you pay off your debt from highest interest rate to lowest interest rate, you'll pay less in the long run.
However, there are a couple of problem with that method:
- Sometimes, as in your case, this creates a tighter cash flow. If you apply all of your windfall to the credit cards, you'll still be stuck paying $550/month toward debt with no flexibility. But if you pay off the other debt completely, you're only obligated to put $300/month toward debt. You can still pay $550/month toward debt (and I'd encourage you to do so), but you've got some slack if shit happens.
- Speaking from personal experience — experience shared by thousands of other former debtors — there's a huge psychological advantage to just kicking one or more debts out the door. "But that's dumb!" some people say. "Why keep the high interest debt?" Because if doing so motivates me to keep paying down my debt, it's a win. When I tried to pay off high-interest debt first, I got frustrated and gave up because I never felt like I was making progress. My case is not unique. Humans aren't completely rational. If you were rational, you wouldn't have credit-card debt. So, consider psychology when making this decision.
In short, don't let anyone try to tell you there's just one way to do this. There's not. Go with what feels best for you and your situation. But please do use that $5,000 to pay down debt.
posted by jdroth at 5:42 PM on January 22, 2011 [5 favorites]
Depending on why you are in debt, it might make sense for you to use the debt snowball method - it uses your money less effectively, but is better at working with the human psyche. If you are in debt in part because you feel helpless and crappy about your finances, the snowball method is recommended. If you are a rational utility maximizer, then pay down the card first.
posted by pmb at 5:49 PM on January 22, 2011
posted by pmb at 5:49 PM on January 22, 2011
The key here is to apply it to make a permanent change in your debt load. Yes, it makes sense to pay off the highest interest rate, and if you had just credit debt that would make the most sense.
But in your case because you have a car loan, maybe that would make the most sense. You won't have the ability to increase that debt again, which if you pay down a credit card (and not OFF) you might just build it back up again. (I've done it. Unless you pay the card down and leave it in a drawer, it might just creep back up again, making your $5k then useless). Think about your past credit card usage and decide that way.
Me, I'd pay off the car loan. Be nice to have the flexibility in my monthly outgo.
posted by clone boulevard at 8:06 PM on January 22, 2011
But in your case because you have a car loan, maybe that would make the most sense. You won't have the ability to increase that debt again, which if you pay down a credit card (and not OFF) you might just build it back up again. (I've done it. Unless you pay the card down and leave it in a drawer, it might just creep back up again, making your $5k then useless). Think about your past credit card usage and decide that way.
Me, I'd pay off the car loan. Be nice to have the flexibility in my monthly outgo.
posted by clone boulevard at 8:06 PM on January 22, 2011
"Basically, if my current card payment is $250 a month and my current car payment is $300 a month, does it make sense to reduce the card payment or does it make more sense to remove the car payment completely so I can use that money towards paying down the card faster?"
Monthly payments are worthless in this decision. Do yourself a favor and try to chart how much of the monthly CC payment goes to interest and how much goes to the debt itself, under the assumption that you never charge another dime. You'll discover it'll take you a damn long time. Decades.
You should pay down the most expensive loan first. This means the highest interest rate. I'm assuming that's the credit card, since it's not secured with collateral. But if you're only making the minimum payments, you're just throwing money away. If your CC monthly payment goes down and you start paying less, you might be retired before you're done paying it down.
The "behavorial finance" model of small wins / snowballing should be studied, not as a brain hack, but so you can guard against it. The remainder is some amateur spreadsheet math. The status quo: If I assume a $5,000 car loan at 5 percent APR, your remaining interest is $193. If I assume a $11,000 CC loan @ 21 percent APR, a 250 dollar payment towards it, and that you direct the extra 300 to the CC when the car is paid off, your remaining interest is $5342. Total interest: $5535.
If you pay off the car first (option b), and put $550 against CC debt a month, your total interest is $2,657. If you pay down the CC (option a), your total interest is $1,833, and your car is paid off in 1 year and the CC is gone in two years. This varies depending on interest rates, total debt, and sticking to paying more than the minimum CC payment. Either way is a wonderful thing, 5000 dollars in payment saves you at least $2,500 in interest! But I hope you see the extra $800 as motivating enough to stick with the smart plan, and that attacking the CC debt is your priority.
posted by pwnguin at 9:48 PM on January 22, 2011
Monthly payments are worthless in this decision. Do yourself a favor and try to chart how much of the monthly CC payment goes to interest and how much goes to the debt itself, under the assumption that you never charge another dime. You'll discover it'll take you a damn long time. Decades.
You should pay down the most expensive loan first. This means the highest interest rate. I'm assuming that's the credit card, since it's not secured with collateral. But if you're only making the minimum payments, you're just throwing money away. If your CC monthly payment goes down and you start paying less, you might be retired before you're done paying it down.
The "behavorial finance" model of small wins / snowballing should be studied, not as a brain hack, but so you can guard against it. The remainder is some amateur spreadsheet math. The status quo: If I assume a $5,000 car loan at 5 percent APR, your remaining interest is $193. If I assume a $11,000 CC loan @ 21 percent APR, a 250 dollar payment towards it, and that you direct the extra 300 to the CC when the car is paid off, your remaining interest is $5342. Total interest: $5535.
If you pay off the car first (option b), and put $550 against CC debt a month, your total interest is $2,657. If you pay down the CC (option a), your total interest is $1,833, and your car is paid off in 1 year and the CC is gone in two years. This varies depending on interest rates, total debt, and sticking to paying more than the minimum CC payment. Either way is a wonderful thing, 5000 dollars in payment saves you at least $2,500 in interest! But I hope you see the extra $800 as motivating enough to stick with the smart plan, and that attacking the CC debt is your priority.
posted by pwnguin at 9:48 PM on January 22, 2011
Definitely use it to get out of debt. I know people say to pay off the highest interest debt first but I followed Dave Ramsey's plan and listed my debts smallest to largest and paid them off in that order. And it worked! I am now debt free.
p.s. Like Dave says, be sure to put $1,000 of the money aside first if you don't have an emergency fund.
posted by MsKim at 10:45 PM on January 22, 2011
p.s. Like Dave says, be sure to put $1,000 of the money aside first if you don't have an emergency fund.
posted by MsKim at 10:45 PM on January 22, 2011
You mentioned that you have your debt spread out over multiple credit cards. Maybe you can completely pay off one credit card that has the highest interest but not the highest balance. That should satisfy both the "debt snowball" people and the "pay off the highest interest rate" people.
posted by claytonius maximus at 11:03 PM on January 22, 2011
posted by claytonius maximus at 11:03 PM on January 22, 2011
i'd pay off credit cards 1st. The key is to stay out of debt once you pay it off. try to continue your payments, into a savings account. Think of it as paying yourself. Living debt-free, or close to it, is a great feeling.
posted by theora55 at 4:50 PM on January 23, 2011
posted by theora55 at 4:50 PM on January 23, 2011
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posted by geoff. at 4:43 PM on January 22, 2011 [8 favorites]