How to make best use of a lump sum of money?
February 16, 2017 3:04 PM   Subscribe

Thanks to a lucrative year for my company stock, I am now possessed of a lump sum of money that I'd like to use to pay off debts/ important expenses.

I am fairly sure I know that paying down credit card debt especially on cards with a high APR is a priority. My credit score isn't good at all, though, and I have the following debt/expenses:

1. ~$8000 in debt between two cards, both with very high APR (>25%)
2. ~$2500 on a car loan
3. ~$1500 on an important personal expense (lawyer for naturalization)
4. ~$3000 on a family trip that I'd like to not forego, but can also save up for that doesn't have to come out of this lump sum.

Assume I'm meeting all household bills and expenses with my paycheck, but am not able to save at all due to paying down the credit cards. The lump sum is ~$13000. I pay 5% of my paycheck into my 401k and 8% into my employee stock purchase plan.

a) What is the best order in which to handle these debts/ expenses?
b) My FICO score is terribly low, and I'd like to start building that. Would paying my debt off fully and then putting a monthly sum on it and paying that off in full at the end of every month be more beneficial; or pay off about 3/4 of it down now, and then pay the rest down in instalments?

Thanks much!
posted by anonymous to Work & Money (11 answers total) 1 user marked this as a favorite

This is what I would do:

1. Find out what taxes, if any, you'll owe on the $13,000. If you will owe taxes, set the money aside now - in a bank account that is somewhat hard to access - to pay them off. (Some people would argue that this is not necessary at this point, especially if you'll owe taxes next year for this, but if you spend all of it in the next year, you could be surprised by a tax bill.)

2. Pay off the credit card debt. All of it - more than 25% interest is a crazy amount to pay. You'll no longer owe the monthly payments for those cards, so that money can be redirected (preferably automatically) into a savings account. If you continue to use your cards (see below to consider if that is a good idea) and pay them on time every month (most important!), your FICO score will improve. There is no benefit to keeping any credit card debt on the cards, especially at that exorbitant interest rate.

[The remaining assumptions depend on there being money left over after you've done 1 & 2. There may not be, but even just ridding yourself of the credit card debt would improve your situation considerably.]

3. Create an emergency savings account and put $1,000 into it.

4a. If your car loan is high, consider paying that off as well and re-allocating the monthly payment into savings.

4b. If your car loan is medium or low, consider paying part of it off. Otherwise pay for the legal services for naturalization or, at least, put the money aside somewhere secure but where you won't be tempted by it.

5. Create a savings account (or sub-account) for the family trip. Put any remaining of the $13,000 into that account and decide how much you can afford to add to it regularly. Set up auto payments to move the money into that account so you don't have to think about it.

As for improving your FICO score, my advice would depend on what led to the $8,000 in credit card debt. If it is the result of an emergency (unexpected medical bills, job loss, etc) and you can be honest and critical say it isn't likely to happen again, then use your credit cards in moderation and pay them (in full!) each month. Set up auto payment online for the full statement amount. However, if you struggle with credit card use, I would try to use cash as little as possible. To improve your FICO score, you can still put one or two small, recurring charges on the cards and set up auto payments.
posted by Caz721 at 3:22 PM on February 16, 2017 [4 favorites]

Snowball it. Pay off the cards. Put the amount of the card payments you've been making towards additional payments on the car loan and pay it off early.
posted by DarlingBri at 3:29 PM on February 16, 2017

My opinion:

1. Pay off the credit cards and the lawyer
2. Put the rest of the lump sum into emergency savings (assuming you don't have any, or an insufficient amount)
3. Use the money you were putting towards credit cards into savings for the vacation
4. Continue to make timely payments on the car

Paying off the credit cards will lower your utilization rate and improve your credit score immediately. Assuming your score is also suffering due to some late payments, the only thing that will help is time and not missing any more (so continuing to pay off the car monthly will actually help.)
posted by ohsnapdragon at 3:36 PM on February 16, 2017 [2 favorites]

To paying off the cards, I would add that you should dump the cards as soon as your credit score improves enough to get better rates.

Also, where the heck are you? Every state has a Usury rate which is the maximum legal annual interest rate allowable by law, and your credit cards must be flirting with it at the very least.
posted by Sunburnt at 3:40 PM on February 16, 2017

If the attorney fee for your immigration work doesn't include the cost of filing, be aware of the additional expense. Given the situation with our assbutt current government, I would prioritize this legal work.

After that, Caz721's advice is sound. Sort your tax situation. Pay off your high interest cards entirely. Snowball the payments you were making on your cards into your car payment and work on getting that gone early. Put everything else into a savings account (Barclays online accounts still have the best APY with flexibility) and work on building it up.

Once you pay off your cards, wait about a month and then call the card companies and ask for your credit limit to be raised. (Don't spend it obviously. Just officially have more available credit.) That'll help with your credit score. Pay your cards off in full every month from here on out.
posted by phunniemee at 3:44 PM on February 16, 2017 [1 favorite]

DO NOT "dump" the credit cards. Get new cards if you want, but keep the old cards open. Closing lines of credit is not good for your credit score.

Also it won't matter what the interest rate is because you won't ever carry a balance again, so.
posted by phunniemee at 3:46 PM on February 16, 2017 [5 favorites]

Let's do the math on this, which previous responders don't seem to have done. Your lump sum is $13,000 gross. You're going to put 5% into your 401K pretax, that lowers it to $12,350. I'm assuming the stock purchase plan is post-tax.

If your marginal federal tax rate is 25% and your state tax rate is 5%, and social security/medicate is 7.65%, that will take 37.65% or $4650. You're now down to $7,700.

Take that, scrounge up another $300 and pay off your credit card debt. There's nothing left, so opt out of stock purchase plan on this lump sum.

That's it. Postpone the trip for next year. Keep paying the car. Pay for the lawyer out of your regular paychecks. Economize on living expenses and don't let the credit balance rebuild.
posted by beagle at 5:04 PM on February 16, 2017 [6 favorites]

Let's do the math on this, which previous responders don't seem to have done. Your lump sum is $13,000 gross. You're going to put 5% into your 401K pretax, that lowers it to $12,350. I'm assuming the stock purchase plan is post-tax.

If your marginal federal tax rate is 25% and your state tax rate is 5%, and social security/medicate is 7.65%, that will take 37.65% or $4650. You're now down to $7,700.

By no means certain that this is only a short-term capital gain, or that payroll taxes are even due.
posted by praemunire at 7:21 PM on February 16, 2017

When I still had credit cards, any "extra" or windfall money always went directly onto those.
posted by turbid dahlia at 7:26 PM on February 16, 2017

Credit cards are generally not subject to state usury laws due to a Supreme Court ruling that allowed them to use whatever rate was legal in the state that they were headquartered in. This seems to work out to the credit card divisions of major banks being headquartered in South Dakota, Nevada, or Delaware, which have no usury laws.

Do not "dump" your older credit cards unless there is a substantial reason to do so. One of the factors that works in your FICO score's favor is the average age of your credit. If you can pay off the old credit card and if there isn't an annual fee, it usually works out better to keep the card. The APR of a card isn't meaningful if you pay it off monthly, or if you do not use it, because they are floating you credit, and there is no interest charge as long as you pay off the bill in full by the time it is due. So you make sure that you never charge something you can't pay off unless it's an absolute emergency.

As your credit score improves, you may be able to ask your bank to convert your existing credit account to a better card. My oldest credit card, I picked up shortly after I turned 18, at which point it was a Student Visa, and then became a Classic Visa, and eventually a Gold Mastercard, then a Platinum, then a Dividend card, but it was all the same underlying account and the current card still reads "Member since ".
posted by jgreco at 3:56 PM on February 17, 2017 [1 favorite]

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