What to Do Before Paying Off Debt?

what to do before paying off debt
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So, you’ve got a lot of debt and maybe you are finally in a position that you can start paying it off, but is that the wise choice? Maybe…maybe not. If you’ve been thinking about what to do before paying off debt, here are a few suggestions that can get you moving down the right financial path.

Things You Should Do Before Paying Off Debt

I found myself in a place where I owned a great deal of credit card debt and student loan debt. (You can read how I got myself drowning in debt here and how I got out of it here and here.)

After some work, I was in the position to start paying it off, and I did pretty quickly, and while getting it paid off was great, there were probably a few things I should have done first.

1.Build Your Emergency Fund

If you don’t already have one, you need to start and build up your emergency fund. This is really important.

Without an emergency fund, when something happens, you will have to use your credit cards or take out a loan to deal with the emergency.

That will only get you deeper in debt.

Amazingly, according to a study by Bank Rate, 63 percent of people don’t have enough of an emergency fund to cover a $500 or $1,000 emergency.

That means they can’t cover a water heater breaking, a car repair, a health scare, or any of the other emergencies that tend to come up each and every year.

So, how much of an emergency fund do you need? That’s up for debate.

You certainly need at the very least a $1,000 set aside, but what if you were to have a bigger emergency or you lost your job?

Some say you should have 3 month’s worth of expenses in your emergency fund. Some say 6 months and others say 12 months.

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You will have to decide at what level you are comfortable. And, if you want to pay off debt as well, you might be comfortable having 1 or 2 month’s worth of expenses set aside before you start paying off debt otherwise you may want more.

The point being, you want to set aside enough money that you can cover an emergency without having to go deeper into debt.

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2. Pay Off Any Back Taxes

If you own any back taxes these must be paid off before you start paying off debt. The last organization you ever want to own money to is the IRS. Trust me, I’ve been there and it is no fun.

Unlike other creditors, the IRS can levy your bank account and garnish your paycheck. This is not the situation you want to be in.

The good news is that the IRS will help you set up a payment plan. The bad news is that if you are late on even one payment, the payment plan will end and they will then levy your bank account.

As I said, I’ve been there. I owed the IRS about $10,000 in back taxes. I set up a payment plan with them. 

All was well until I sent a payment just a few days late. It wasn’t on purpose. I just didn’t have the money available on time. I didn’t think anything else about it.

I kept making monthly payments and in my mind, all was well. That was until one day I went to take some money out of my bank account and all the money was gone. That’s right. All of it.

Because I was late on that one payment, the IRS had canceled my payment plan. I never received anything from them to let me know that had happened.

It didn’t matter that I had continued making payments.

I also didn’t receive anything about them taking money from my bank account until a few days after it happened when I got a letter from the bank. I never heard anything about it from the IRS.

I only knew about the money being gone from my account because of that trip to the ATM.

It was a real mess and a difficult lesson to learn.

It’s not a situation you want to find yourself in. That means that if you owe any money to the IRS you need to pay it off before you start paying your other debts.

I’m happy to say, I did get that $10,000 paid off and I have never had to deal with that type of situation again.

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3. Decide What Debt to Pay First

I know it is a great feeling to pay off debt. It certainly was for me when I had a lot of it, but you don’t want to just dive in headfirst.

You need to make a plan. 

First, determine which of your debts have the highest interest rates. You will want to pay these off before any others. 

If you have any payday loans or car title loans, it is a must to pay these off before any other debt. The interest rates can be up to 500% a year. Not to mention, about 93 percent of people with car title loans lose their cars.

After that, you will want to pay your credit card debt as these have the next highest interest rates.

Then you will want to look at any personal loans you may have and pay those next.

So, the point is, organize your debt by interest rate and start with the highest and pay those first and then go down the line.

Typically, they will fall in this order.

  • Payday loans and car title loans
  • Loans for those with bad credit
  • Credit cards
  • Personal loans
  • Auto loans
  • Mortgages

If you plan out what debt to pay off first carefully, you will find that your monthly payments decrease faster and you will get out of debt more quickly.

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Related Questions:

Should You Invest Before Paying Off Debt?

The only time you should invest before paying off debt is if the investment will give you a higher interest rate than the interest you are paying on your debt.

For example, if you have a loan you are paying 5 percent interest on and you find an investment that will pay you 8 percent interest, then it makes sense to invest before you pay off your loan.

Most of the time, however, it makes more sense to pay off your debt first. This is especially true if you have high-interest debt such as credit cards or payday loans.

Is It Better to Put Money in Savings or Pay Off Debt?

You want enough money in an emergency fund, which is typically a savings account, to cover unexpected events, so you don’t have to add to your debt to cover the expense.

Beyond that, you want to pay off debt instead of putting money into a savings account. Most savings accounts will pay you about a quarter of one percent on your money. 

Chances are, you are paying anywhere from 6 percent to 22 percent on your debt, so get that debt paid off first.

To Sum it All Up:

There are a few things you should do before you pay off debt. Make sure you first have an emergency fund, pay off any IRS debt, and organize your debt before you start paying off debt. That way your financial situation will improve faster and you will be able to sleep easier at night.

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