Last year, the average U.S. consumer carried $6,576 in credit card debt. Earlier this month, the average credit interest rate stood at 14.5 percent.
With so many people struggling with large balances and high interest rates, Money Talks News founder Stacy Johnson gets asked this question more than most: Do I pay off my debts or save for retirement? Check out his answer in the video below, then read on for details about what you should do…
Deciding what to pay first
When you’re trying to reach your financial goals, you have to decide what investment will give you the highest return. Compared to the rate of return on a typical savings account, CD, or stock investment, you’ll have a higher rate of return by paying off your credit cards first.
Say you have $7,000 in credit card debt and a 15 percent interest rate. If you pay the minimum payment of $157.50 (2.25 percent) on your credit card, it will take 25 years to pay it off. During that time, you’ll pay $8,229.16 in interest.
On the other hand, if you paid $300 a month toward your credit card balance, you’d have the debt paid off in 28 months – and you’d only pay $1,328.13 in interest.
As Stacy said in the video, if you’re paying 15 percent on a credit card, paying it off is like earning 15 percent tax-free and risk-free. That’s hard to beat.
But there’s an exception to this rule: a 401(k) or other type of retirement plan that offers a company match. In these plans, your employer matches your contributions up to a certain amount, typically 50 percent of whatever you contribute, capped at 6 percent of your annual salary. So if you earn $50,000 annually and contribute $3,000 (6 percent) to your retirement plan, the company will contribute $1,500.
That’s free money: something hard to come by!
If your company matches any of your 401(k) contributions, make sure you’re contributing enough to get every free penny being offered by your plan. After that, put any extra income you have left into paying off your debt. Once your debt is wiped out, then you can start contributing more to your 401(k) – or looking into other investment options.
Getting it done
Now that you know what to pay and when, you’ll need to come up with the cash.
Talk to your HR department, find out what your company matches in 401(k) or retirement contributions, and set your paycheck to automatically withdraw that amount. Since the money is coming out automatically, that’s one less thing you’ll have to worry about.
Then follow these steps to find the money to pay off those credit cards:
- Create a simple budget using your lowered take-home amount. Check out Resolutions 2012 – Budgeting Your Way to Happiness for tons of helpful tips.
- Use your budget to figure out how much you have left over each month. Most of that money (if not all of it) should go toward paying your credit card debt. Plug the amount into the Federal Reserve’s Credit Card Calculator to see how long it will take you to pay down your balance.
- Trim the fat off your budget if you want that debt paid off faster. There are loads of painless ways you can save without sacrificing your quality of life. Check out 25 Simple Ways to Save an Extra $1,000 for ideas.
- Find new ways to contribute to your retirement funds. As soon as you’re close to paying off your credit cards, look into new ways you can make a better retirement for yourself or your family. For example, you might use your extra funds to invest in stocks, or maybe you’ll find a great rate on a CD. For ideas check out 4 Ways to Invest Without Much Money.