Beginning this week, we should see government stimulus money deposited in American bank accounts. A family with a few kids can be looking at a decent little bump. But if you won the essential worker lottery maybe you don’t need that bump. So, what is the best way for you to put that money to use?
One thing to think about is what situation you would be in if you were not an essential employee? Where would the pain points be? What expenses do you have that would prohibit you from paying your necessary expenses if your income was dramatically impacted in a crisis? At the top of your most wanted list should be credit card debt. Your stimulus payment can be the perfect opportunity to tighten up your financial situation.
There are some proven debt payoff strategies to look at when you decide to do so. Each have their benefits, but it really comes down to personal preference.
Anyone familiar with Dave Ramsey’s work has probably heard about the snowball method of paying off debt. The strategy is pretty simple. Pay off your debt balances starting at the smallest and apply freed up cash flow to the next smallest balance. Rinse and repeat until you are debt free. This is how that may look with an added stimulus payment.
In this example you would completely pay off Card 1 and put $2,400 towards Card 2. Going forward you would add the previous minimum payment from Card 1 to Card 2. You would pay off Card 2 in approximately 2 years. At this point, you can apply the payments you were making toward Cards 1 and 2 to Card 3. You would eliminate this debt 4 years earlier than just paying each card’s minimum payment. The cash killer when it comes to debt is the interest payments you make over the life of a loan. Using the snowball method, you save nearly $15,000 in interest payments. That’s a real stimulus.
While the snowball method is great, the avalanche method will save you even more time and money. The popularity of the snowball method is its psychological effect. Each debt you pay off along the way encourages you to keep going. To pay off your debt quicker and save boatloads in interest, however, use the avalanche method. Instead of paying your debt in order of smallest balance you go in order of highest interest rate. This method is preferred when considering the raw numbers.
With the avalanche method you would apply the stimulus to Card 3. You would continue to pay the original payments and in approximately two and a half years Card 2 would be paid off. That payment would then be added to Card 3. In just over three years the entirety of the debt would be paid off and you would have saved over $20,000 in interest payments over just paying the minimum payments.
Keep in mind these two examples are using only the minimum payment amounts. Any amount you can add to the minimum payments would speed up the payoff and reduce interest expense.
The next trick is to keep credit debt to an absolute minimum. It feels amazing to be out from under the thumb of credit card debt. Remember what it feels like when you have it looming over you before you return to habits that lead you to that point. Holding credit card debt is a gas leak in the car taking you to your financial future. Fix the leak, quit poking holes, and drive safe.