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How to Pay Down Debt & Establish a Solid Financial Foundation

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Credit Card DebtNotes from Jim: I’ve been fortunate in my adult life to have avoided credit card debt. As a result, I don’t have first hand knowledge of what it’s like to have to repay high interest debt and establish a solid financial foundation. So to help me get that perspective, I worked with Amber of Coupon Connections to come up with a post that I think is helpful for readers looking to make that transition. Please let me know what you think in the comments!

Prompt debt payment is necessary in good money management.

Of the many things that were taught to us in the 12+ years of education, personal financial management was not among them. Yes, we were taught how to count, add, subtract, multiply and divide. But, unless you voluntarily studied financial management, you were never really taught extensively about interest rates, compound interest, risk management, etc.

Additionally, most of us were not oriented well enough about the many risks that life puts us in. Job loss, hospital emergencies and calamities are just some of the things that will put a huge dent on our budget or throw a wrench on our financial plans.

Perhaps, you are already in a mountain of debt and need to badly pay them off. But, you are interested to get into investments, as well, so you will have additional income down the road. And yet, your income and cash resources are limited. You can’t do both, so which should you do first?

Which should you do first? The simple formula is: Settle your debts, build up some emergency cash, and then invest money. A positive side effect of following this path is that by the time you have the first to steps completed you will definitely have learned the value of your money before you start making investment decisions.

Settling Your Debts

Generally speaking, paying off your debt on a timely basis is a priority. Why? Paying your loans when they come due is a must, so that you will not be slapped with late fees and additional interest. Additionally, in some creditor-debtor agreements, overdue term payments will make the rest of the payments due and demandable immediately. What does that mean, exactly?

Say, for example, you borrowed $1,000.00 (for simplicity sake), and you are expected to pay $100.00 every month for 11 months (inclusive of a 10% straight interest). If you miss one or a couple of installment payments, some creditors will demand for the full payment of $1,100 (or the balance if you have made some payments already), even if you are still in the middle of your payment period. Moreover, they will ask for late fees and additional interest for EVERY day that you are unable to pay off the full amount.

What used to be just a $100 interest (which can be defined in layman’s terms as money you pay to someone for letting you use his or her money) will amount to half or even twice or more than the original amount of the loan. Some end up paying $2,000 or more on fees and interest for just a $1,000 loan. You can contest this in court for usury, but that will be a protracted and expensive process (the justice system also cost money you know).

Learning the Lessons

The lessons here are: read the fine print on your loan agreement before penning your John Hancock on it, so you are aware of what you will have to deal with in the eventuality that you have to miss a payment or two; and most importantly, make sure to pay when your debt or installment becomes due.

If you have several loans and cannot pay them off all at once, prioritize paying your balance on your credit card whether they are due or not. Why? Paying off just the minimum due amount is expensive for you in the long run. Credit card companies make money from huge fees and hidden interests that most of their customers are not vaguely aware.

Take note that credit cards are supposed to be for convenience and emergencies. They should not be made a source of purchasing power for money that you do not yet have, most especially for unnecessary purchases.

Building Your Emergency Fund

When you’re done paying off your debts, loans and credit card payments, the next logical step would be to build up your emergency fund. This should be good for at least six months of your total household expenses (food, groceries, utility bills, Internet/cable, gas, cellphone payments, miscellaneous household expenses, etc). Emergency funds are very useful. They can serve as your backup when money is tight and you don’t have a stable cash flow.

There are many ways to create an emergency fund. You can open a separate savings account and link it to your main account. Every payday or so, credit a portion of your balance from your main account to your emergency fund savings account. The desired percentage is 5% to 10% of your salary. Many online banking systems can automatically do this task for you. You’ll just have to link the two bank accounts, specify a schedule and indicate the amount you want to transfer. If you don’t know how to do this, you can ask help from your trusted bank officer.
When you have enough emergency fund, you can now start investing your excess money.

Know How to Manage Your Money

For anyone who just started to work and already has the experience of having his or her own money, a working knowledge on personal financial management is a must, lest you find yourself with huge loans to your name and a bad credit rating, or penniless even days before your next payday. How many people do you know have expensive clothes, gadgets and hang out in expensive places but when they had to make big item purchases like a house or a car, they can no longer take out a loan from a bank due to bad ratings on their credit cards?

If you are averse towards Math and get headaches when crunching numbers, you should try to have a different perspective on the matter. Do not justify by saying the most often thrown excuse: “That’s why I took Philosophy (or Mass Communications or Liberal Arts or [insert some other course here]), so I do not have to do Math.” Well, here is some bad news for you. You HAVE to do some numbers crunching if you are to properly manage your money.

Curbing your debt and paying them off promptly are just some of the necessary steps anyone has to undertake to properly manage their finances and get the most out of their money.

Amber BustanobyAbout the Author: Amber Bustanoby is a Savings.com DealPro, personal finance expert, and founder of Coupon Connections, a website helping others learn how to coupon quicker and easier.

(Photo Credit: lemonjenny)

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2 Responses to “How to Pay Down Debt & Establish a Solid Financial Foundation”

  1. Brandon says:

    I think the postscript to this post should be something along the lines of this: don’t let digging out of debt or laying a good financial foundation allow lifestyle inflation to undo all of your hard work one you have achieved your initial goals.

    Lifestyle inflation, expenses creep, or whatever you want to call it can be deadly. The bottom line is that once you become proactive in improving your financial situation, you should also be vigilant about continuously saving more, investing more, etc. Don’t “set it and forget it.”

    Anyway, that’s sort of vague and less actionable than your ideas but I think it’s important to throw out there as it seems to be a common problem.

    Thanks for the good post!

  2. Devin K says:

    Amber,

    thanks for the insight! I am like Jim, fortunate enough to have avoided credit card debt so far in my young adult life, but I am busy paying off student loans month to month. Money management and emergency funds are great ideas for anyone with or without debt! I need to get on an extra savings account in the near future for sure.


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