Often we get questions from listeners behind the scenes. This week, one of our listeners messaged us because she received an unexpected inheritance of about $29,000.00.
They still have some credit card debt and unpaid medical bills. She wants to save some and also put some money away for her grandson’s college. They only have $400.00 in a small savings account.
Before I could begin there were a few things I wanted to know.
I wanted to know what the interest rates were on each of the debts. I also wanted to know how much paying off the debt would free up in her budget.
We discussed the benefits of both the debt snowball and avalanche methods of paying off debt and why one might prefer one over the other.
DEBT SNOWBALL VS. AVALANCHE METHOD OF PAYING OFF DEBT
In the debt snowball method, you pay off debts in order from smallest balance to largest. This is to give you momentum quickly and helps overcome mental obstacles you might have when it comes to paying off debt.
In the avalanche method, you pay off debt in order of highest interest rate to smallest. This looks purely with respect to the numbers. The higher the interest the greater it costs you every month to carry that debt.
WENDY AND CURT’S RECOMMENDATION
After getting some of these questions we suggested the following:
Step 1: Put another $600.00 in a baby emergency fund to bring that balance up to $1,000.00.
Step 2: Pay off all the debt. This will leave a bit under $18,000.00 left of the original $29,000.00. This will also free up $600.00 a month that was going to debt service.
Step 3: Fund retirement accounts for this year.
Step 4: From the $600.00 take a small amount, no more than $25-$50 and begin a 529 plan for her grandson.
Step 5: Take what’s left and fund a 3-6 month emergency fund.
Step 6: If the 3-6 month emergency fund is not fully funded, take the rest of what is left from $600.00 a month that was going to debt service and fully fund the emergency fund.
Step 7: If the emergency fund IS fully funded at this point, then the 529 plan can be increased and begin funding after-tax investments.
If you have a scenario, you would like our input – feel free to leave us a voicemail or send us an email at firstname.lastname@example.org.
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