What Comes First? A Step-By-Step Guide to Financial Independence. Step 2: Pay Off Your High Interest Debts
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Welcome to the next installment of the Step-By-Step Guide to Financial Independence here at Independent Beginnings! Yesterday, I introduced Step 1: Set Up an Emergency Fund. In Step 1, you were encouraged to set up an emergency fund equaling $1000 or 1-month’s worth of expenses, whichever is higher. Once this preliminary emergency fund is set up, you are ready to move on to Step 2: Pay Off Your Debts.
Step 2: Pay Off Your High Interest Debts
In Step 2, you are going to aggressively attack most of your debts. This should be your primary focus before ever considering investing in the stock market. Some people do not agree with this. Some people believe that you should start investing for retirement before your debts are completely paid off . While there are certainly good arguments in support of that position, I tend to side with Dave Ramsey in my belief that becoming debt free is more important than building up a huge retirement fund. If you do not have any significant amount of debt, then feel free to move on to Step 3.
Which Debts Should You Pay Off? There are many different kinds of debt and not all debt is created equal. Some debts have huge interest rates and fees, while other debts have low interest rates and actually make you money in the end. The first type of debt is what we are attacking here. These debts include credit card debt, car payments, and other high-interest purchase payments. Home mortgages (first ones),low interest student loan debts, and other low interest business loans are not our primary targets at this point. This is one place where I disagree with Dave Ramsey. Dave Ramsey believes that every debt other than your mortgage debt should be paid off at this time. I, however, believe that while the high interest debts should be aggressively paid off at this time, the low interest debts can be saved to be paid off gradually. The reason I say this is because, similar to the people I mentioned above, more good can come to you by making the minimum payments on low interest debt and investing the rest into your retirement account than can come to you by holding off on your retirement account and aggressively paying off these low interest debts.
Why Should You Pay Off Your High Interest Debts? High interest debts cause nothing but trouble. They can drastically limit your financial freedom, cause a great deal of unnecessary stress, and greatly reduce your future purchasing power. Paying off these debts as soon as possible will save you a large amount of money in interest in the end. It will also save you a large number of headaches.
How Should You Pay Off Your High Interest Debts? There is a lot of debate about the best way to go about paying off your debts. One thing that is agreed, though, is that at this step all of your extra money needs to be put into your debt payments. The two leading strategies for paying off your debts come from Dave Ramsey and Suze Orman. To see a comparison of both of their strategies, see my article Paying Off Debt: Dave Ramsey vs. Suze Orman.
With your high interest debt paid off, you are now ready to move on to Step 3! Check in tomorrow to see what it is!
Articles so far in the series:
- Step 1: Set Up an Emergency Fund
- Step 2: Pay Off Your High Interest Debts
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