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When it comes to retirement planning, understanding your current debt is important. Not all debt is created equal. If you locked in a low-interest fixed rate mortgage, it’s generally not beneficial to pay off this amount faster than scheduled. On the other hand, if you have a balance on a high-interest credit card, that debt is more urgent to address.
There is not one right method to pay off debt, but it is important to understand your motivation to pay down your debt and create a plan that you will stick with. The sooner that you can pay off your debt, the sooner that your money that can go towards saving to build an emergency fund, for upcoming travel or large purchases and for retirement.
Advantages of Paying Off Debt Before Retirement
Your retirement account, such as a 401(k) or IRA, is one type of account (tax deferred) to help you save and invest for retirement. Once you have determined your plan to pay off debt, you can better maximize your dollars in the following ways.
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Break up with debt- adjust your spending to allocate more of your income to take down your outstanding debt. These changes can make lasting positive changes in how you spend, save and invest in the future.
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Less interest- the faster your debt is paid, the less it will cost you in interest.
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Improved credit score- with a lower outstanding debt balance, you should also benefit from a higher credit score.
What Type of Debt is Most Important to Pay Off?
Prioritize paying off debt with the highest interest rate. For many people, that’s credit card debt. Also included is unsecured debt with large balances, like private student loans. Secured debt, like a car loan or mortgage, has collateral behind it. Include these monthly payments as part of your budget, because if you fail to pay these loans, you risk losing the asset.
Most Effective Way to Pay Off Debt
The most effective way to pay off debt depends on your motivation and your plan. Start by listing all of your secured and unsecured debts. Rank them from the highest to lowest interest rates and by balance. Examine all of your current spending and find ways you can cut back while you allocate more money towards paying off debts. Two methods to consider are outlined below:
- Snowball method – This method involves paying off the smallest debt first. Make minimum payments on all other debts. Once the smallest debt is paid off, repeat the process with the next smallest debt, and so on.
- Avalanche method – Pay off the debt with the highest interest rate first. For all other debts, pay the minimum. Again, once the debt with the highest interest rate is paid off, start paying off the debt with the next highest interest rate.
You can pay down debt before or simultaneously while you save towards your retirement.
For more information on saving and investing for retirement, contact a financial advisor at EP Wealth Advisors today.
