What should I do with the money in my savings account?
I am single, 50 years old, and I have a pension and 401(k). I have $10,600 in credit card debt (one credit card's balance is at $4,300 with no interest and another balance of $6,300 with 15 percent interest) and two personal loans totaling $27,000 (one loan's balance is at $7,000 with 11 percent interest and the other is $20,000 with 11 percent interest).
I recently sold my car for $18,000 and placed the money in a savings account. What should I do with this money?
Assuming you are working, I suggest keeping six months of expenses in a savings account (emergency fund) and using any surplus above that to reduce and eventually eliminate all of you debt. You are hurting your short and long term investment prospects by borrowing money. You still have 15 years of productive, income earning years ahead and you should maximize your savings while you can. The power of compounding interest can work against you when you have debt or for you if you don't have it.
There are two uses for this money. It important for everyone to have emergency cash reserves. If you do not have cash in the bank or credit union to be used in the case of an emergency, some or all of the $18,000 go there. How much should you have in emergency cash reserves is a judgement call on your part. If it is unlikely you will have emergencies requiring more than a couple of thousand dollars, then $2,000 should suffice. Remember, this is money to be used for costs that are not covered by the insurances most people have (medical, auto, homeowners, etc.). The balance of the $18,000 not set aside for emergencies should be used to pay down/off your 15% credit card debt. If you still have some funds left the apply the balance toward paying down either of the 11% loans. Take the monthly income that is no longer needed to make monthly payments on the 15% credit card and add it to what you are paying on the 11% debt.
Since you are unlikely to have ANNUAL rates of return higher than what the loans are costing you (15% or 11%), don't think about investing the money.
When you are paying down debt, you are, in essense, paying for past consumption. After making loan payments, how much of your income is now left to invest in the future? Always remember, you can't pay retail plus15% and make any financial headway. Only use the credit card if you absolutely know you can pay it off in full at the end of the month. If you can't pay off the credit card in full every month, find a cheaper way to borrow money (home equity loan, personal loan from bank or credit union, etc).
Phillip Cook, CFP
First, pay off the high balance credit card. You'll sleep better.
Second, pay off the smaller of the two personal loans. Now you'll sleep so well that you'll have a hard time getting up in the morning.
Third, take the combined amounts of what you were paying on these two paid off loans and put 50% in savings (for emergencies) and the other 50% will be added to your payment on the $4300 credit card balance because even though you are not paying interest now, you will be if you don't get this paid off!
Fourth, take the combined amounts (including for your newly paid off "non-interest" credit card) and put 50% in savings and the remainder to your outstanding personal loan.
Or instead, do what one of the other advisors recommend. Because no matter which direction you choose to go, the most important step is to create and follow a plan with both determination and discipline.
First, make sure you keep cash reserves (in the bank) of 3 - 6 months worth of living expenses (net of taxes and savings). Second, pay-down/off any debt that is costing you five percent or more, starting with the highest interest rate loan(s). Finally, if there is still money left over, or when money become available in the future, that you don't need for cash reserves and don't need for the next 5 years (and hopefully longer), invest and stay invested no matter what happens in the markets.
Does any of the $18,000 need to be used for another car? If not, then you should look at keeping enough of it in cash to cover 3-6 months of expenses and emergencies. After that, analyze what got you in debt in the first place. If cash flow is a continual issue, keep all in cash until you fix that. Otherwise paying down the debt will only lead to the same issue in the future. If the debt was due to immediate and unexpected NEEDS (such as health events), then the cash reserves should help reduce the future impact of such events and you can feel comfortable using the surplus to pay off the debts starting with the $6300, then the $7000. Caveat: if the $4300 0% interest is promotional and temporary (for xx months from a purchase of (usually) a retail item,) you should pay that off first since in those tpyes of lending the fine print usually states that failure to pay off by the term deadline results in the new interest rate being retroactively applied to the entire balance you originally had. It's often overlooked and the "trickery" often burns many who use these types of financing, often to financially disastrous results, so get it taken care of.