An unexpected windfall is probably one of the best things that can happen to someone in debt. At the same time, it can be difficult to decide where to apply those funds. Should you be so lucky to have this problem, there are a lot of things to consider, like the interest rates on your debts, the debts that hurt your credit most and what choices would make you happiest.
A Reddit user found himself on the receiving end of an unexpected $7,500, and he took to the Internet for advice on how to use it. He gave the following breakdown of his debt:
- $400 on a credit card with an interest rate of 20.99%
- $6,888 personal loan at 10.5% ($244 per month)
- $14,300 auto loan at 1.9% ($375 per month)
- $100 in parking tickets
- $684 collections account
- $640 collections account
- $275 medical bill
- $148 medical bill
His plan, he wrote, is to put $500 toward his emergency fund and pay off the $400 credit card debt. He really wants to get rid of the $6,888 loan, but he asked for some advice from the Reddit personal finance community.
There are a lot of ways the Redditor can approach this decision. To make the process easier, he can look at the pros and cons of his potential choices. I won’t go over all of them, because dividing the money among different debts presents a lot of possibilities, but there are several choices likely to leave this guy satisfied with the way he used his money.
Building savings is a great idea, and unexpected money presents the perfect opportunity to bolster an otherwise thin rainy-day fund. You don’t need to win the lottery for this — a tax refund, work bonus or gift money could be a perfect foundation or addition to this crucial savings account.
Gerri Detweiler, Credit.com’s director of consumer education, had a few suggestions for the post writer:
“Yes, build up emergency savings,” she wrote in an email. “If the total you get after taxes is less than you think, you might make the emergency savings slightly smaller.”
These debts probably don’t carry interest, so they may not be your highest priority, but medical bills are notoriously messy.
“We’ve heard from many people who have been suddenly turned over to collections for medical bills on which they are making payments,” Detweiler wrote. “They are small and it’s probably better to get them off your plate. ”
Sometimes, small things are credit killers (if you want some examples of these horror stories, give this a read), so think about the potential for more headaches before overlooking the small stuff.
While these aren’t often as problematic (or expensive) as medical bills, parking tickets can find their way to debt collectors, and you don’t want your credit score to suffer because of a measly parking ticket. On the other hand, chipping away at high-interest debt is more appealing than eliminating parking tickets.
The tickets are just one more thing you can cross of your list, so it’s probably time to pay up and move on.
Speaking of high interest rates: It’s a good thing his credit card debt is a priority, because that $400 will grow fast. “The interest rate is ridiculous,” Detweiler wrote.
Paying off credit card debt has multiple advantages. First, you get to enjoy the relief of being out of credit card debt. Second, you will likely raise your credit score in the process. One of the biggest factors in determining your credit score is how much of your credit limit you use (you can see your credit utilization rate for free with a Credit.com account), so lowering or eliminating your balance will improve that ratio.
Contrary to popular belief, paying off collections accounts does not improve your credit score (unless the model is VantageScore 3.0, which excludes paid collections accounts). For that reason, paying off these accounts may not be a high priority when deciding what to do with an extra $7,500, but Detweiler suggested he try to settle the collections accounts.
“Depending on how old they are, you may be able to settle them for less than the full balance — shoot for 50% and see what happens,” she said. Taking care of those means the debts won’t be sold to other collections agencies and add another collection account to your credit report. (Note: You should check the statute of limitations on the debt, because if it’s too old, you shouldn’t have to pay. Here’s how to figure that out.)
Based on the writer’s post, it sounds like that $6,888 loan is really grating on him. Considering his other goals, and the fact that he may have to pay taxes on the $7,500, it may not be realistic to try and eliminate this one right now.
That doesn’t mean he can’t make progress. Throwing a chunk of money at the debt will at least reduce the total balance, making it easier to tackle in the future.
After the writer posted his original message, he received a slew of advice from the community, and he posted an update saying he used $100 of his emergency fund to knock out the parking tickets and plans to focus on that pesky loan. He ended the post saying the decision “Feels great,” and sometimes, that’s the most important part of the decision.
More on Managing Debt:
- The Credit.com Debt Management Learning Center
- How to Pay Off Credit Card Debt
- 5 Tips for Consolidating Credit Card Debt