If you’re carrying debt but also need to start crafting your financial parachute to be ready for when you leave the workforce, you have to make decisions about where you want to put your money, and when you’ll need to start acting on those decisions. Experts may disagree on how to prioritize, so look to your specific financial circumstances to weigh the pros and cons of each option and anticipate their impact, not only on your current bottom line, but also on your credit score and financial future.
Emergency Fund First
Before you begin to worry about whether you should pay off your mortgage or contribute as much as possible your 401(k), you may want to start an emergency fund to handle short-term financial emergencies. U.S. News recommends an emergency fund of at least three months of expenses – but it’s better if you can extend the fund to cover six months. Financial gurus at Money Crashers recommend a minimum of six months in your emergency fund. If you face an emergency without an emergency fund, your options can be unpleasant: facing stiff tax penalties to tap your retirement plans early, or damaging your credit score if you miss bill payments. You might even have to turn to high interest loans to cover your expenses.
One way to help decide whether to prioritize your debt or retirement savings is to compare the rate of return on your investments in your retirement plan to the interest rate you’re paying on your debt. If you’re getting a higher return on your retirement savings, your bottom line goes up. However, if you’re paying a higher interest rate, your net worth takes a hit.
Paying Down Debt
Besides avoiding interest payments, paying down your debt first has the added bonus of keeping your credit in better health. According to Experian, a significant part of your credit score comes from your credit usage, which compares your balances with your credit limits. When the debts are high, your credit score can lower. Worse, a weak credit score can cost you money in the long run when you apply for additional debt, like a mortgage or car loan, because you may not be viewed as currently using credit very responsibly. In addition, your insurance premiums can also be affected by your credit score.
Track Your Finances
When you put money in the bank or take out a loan, it may be wise to track how you’re doing on payments from month to month with your account statement. That way, you can make sure you’re staying current and see how much progress you’re making toward paying off your debt. Similarly, you can track your retirement savings accounts to see how your investments are performing. Knowing where you are on your financial journey at all times is key to making wise decisions for your future.
You can also track your credit score as you work toward paying off your debts. In addition, regularly checking your credit report helps avoid any suspicious activity from staying on your credit report and even impacting your credit score by allowing you to catch it and take actions to remove it sooner, which is important to know if you plan to apply for additional credit at any point in the foreseeable future.
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About the AuthorMark Kennan is a freelance writer specializing in finance-related articles. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.
This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.
Published by permission from ConsumerInfo.com, Inc., an Experian company. © 2014 ConsumerInfo.com, Inc. All rights reserved.