Best way to pay off debt?
DFA reader Stacy asked:
Dear Matt, I have been in military service for 20 years. I will be retiring in about 14 months. Unfortunately I haven’t been the wisest money manager. I Have:
- $69,986 Mortgage @ 5.5% with a minimum payment of $541
- $16,954 Car loan @ 18% with minimum payment of $614
- $5833 Credit card @ 9.9% minimum payment of $200
- $5100 Student loan @ 2.47% variable with minimum payment $60
By cutting back on unneeded expenses I will have an extra $600.Should I work towards paying the higher interest rate off first? Or work from lowest to highest? Also, I will only have this extra money for 14 months. I am working to get as debt free as possible before retirement. Your assistance is greatly appreciated.
How I would pay off the debt
Hi Stacy, thank you for your question and thank you for your service.
If it were me I would sell the car, pay off the auto loan, and buy a used vehicle for around $3,000 – right now you’re paying more for your car than your home. If you’re unwilling to do that then focusing your debt snowball on the auto loan first is a must. It will give you the biggest bang for your buck because it has the highest interest rate. Since you will have the extra $600 for the next 14 months, you should be able to pay the auto loan off by around August or September of 2012.
After your auto loan is paid off, you will no longer have the extra $600 but you will have freed up the $614 that used to go toward your car payment. Next put that extra $614 toward your credit card. Once you pay off the credit card debt you will have $814 extra to put toward your student loan. Some may advise you to put it toward the mortgage before the student loan, but don’t. Your home is your asset against your mortgage… you have no asset against your student loan, plus it is a variable rate loan, so pay that off next. After you pay your student loan off you can focus all efforts on eliminating your mortgage.
Student loan forgiveness for military personnel
Since you are in full-time military service you may qualify for student loan forgiveness… have you ever checked into that? Follow this link for more information and to find the necessary forms to apply for loan forgiveness.
Budget your money and save
I always make it a point to make sure people are budgeting and saving money. Do you have a working monthly budget? If not, you need one. You can either use my budget worksheet or a budgeting software program – I recommend You Need A Budget.
Are you saving money and do you have a savings buffer currently in place? If not, start saving. Build up at least a $1,000 emergency fund to help you avoid using your credit card. If you don’t have money for emergencies – and emergencies will come – then you’ll never break the cycle of credit card spending.
Thanks again for your service Stacy… and congratulations on taking steps to pay off debt and better manage your money. If you follow this advice you will have success. God bless.