Pay Yourself First
Pay yourself first is a great concept. Right now you are paying the credit companies first, not a good place be. You need to take at least 10% off the top of your take home income and pay it toward your own wealth building.
Since you have figured out how much extra you can come up with each month, a good question to consider is should I invest it or pay down debt?
When you pay yourself first it is important to consider all aspects.
Most people will tell you to pay off high interest loans first. And I highly agree. Because if you have a card at 20% interest rate, but are investing at a fixed 7% interest rate. It is costing you 13% every month on that money you could have paid to debt.
When you pay yourself first by paying off those high interest loans it can be compared to getting a fixed 20% rate of return. Because when you make a payment that goes mostly to principal you are saving the 20% extra you would have paid on that money.
Let me rephrase this, it is a credit card wealth secret. If you pay off a credit card at 20% interest rate it is exactly the same as investing in a money market fund and receiving a fixed 20% interest rate. Since that fixed rate of return is unheard of, this should get your attention. The interest that you would have paid to someone else now stays in your pocket. You end up with more money and less debt.
Always pay off your high interest loans first. Then call the credit card company and cancel that card. In fact you can cancel the card before its even paid off. It just means you cannot access it anymore. You cannot reach that debt even though you are paying on it. (Be sure there are no penalties for this action.)
Now that the big monkeys are off your back you can take a breather and reacess your situation. It is important to have at least a 3-month supply of money saved in case of emergencies.
Put this in a fixed money market account or something that will get a decent rate of return but is accessible in case of unforeseen problems. Such as loss of income or major medical needs, etc.
It may not be a bad idea to save just one credit card with a zero interest rate for only emergencies until you have saved up your own cash emergency fund.
In the transforming debt into wealth program Mr. John Cummuta recommends putting the card in a metal container, filling it with water, and then freezing it. This is a great way to Stop getting more debt and still have a credit card safety net.
That way you cannot throw it in the microwave to thaw it for impulse buys. But will wait a day or two for real emergencies. Pay yourself first from your paychecks and save up a reserve soon.
After you have done that, and maybe you are already there, there are many varying opinions. Some say it is time to invest, just pay off your home loan & student loans by the time your retire, but no rush. Reason being that the interest from these loans is normally lower, and because it is tax deductible.
Lets think about this. If you are in the 25% tax bracket that means for every dollar you spend on interest, you dont have to pay $0.25 in taxes. So you are spending $1 to save $0.25.
I gotta tell you that doesnt make a whole lot of sense to me. Because you could be taking that additional $0.75 were paying in interest to the bank, and pay yourself first with it, invest it and become wealthy instead of making the bank wealthy.
Lets break this down another way. Say you just bought your home, and got a loan for $150,000, a 7% interest rate, and a 30-year fixed. This makes your payment $1000/mo. (easy math in this case).
If you took the full 30 years you will pay a total of $360,000. So you paid $210,000 in interest. What if you paid off that home in 6 years. And then pay yourself first, by taking that payment you were sending to the bank and instead invest it for your retirement.
You could put that in a tax shelter of some sort and be much better off that paying $210,00 in interest, getting a little better tax rate and not having that a large chunk in retirement. The same is true for student loans.
But if you really think this is a good idea. Come on over to my house and for every dollar you give me I will give you $0.25.
So in recap. Pay off those high interest loans and credit cards FAST! Then make sure you have a little set aside for an emergency. Should only take a few months. Then start paying down your house, student loans, and lower interest debt.
Finally after all that is done you will be able to invest all your new found monthly income toward retirement, vacations, whatever you want. But you can get all those things without debt!
"A man in debt is so far a slave,"