Over the last few weeks, several readers have written in asking me what I’m going to do with my economic stimulus check, perhaps in hopes that it would give them some idea as to what to do with it. I thought that walking through my plans for the money might give some people insight into how I make my financial decisions.
Here’s my family’s exact plan for the $1,800 we’ll soon be receiving: every single dime of it is going towards my wife’s student loan.
For some of you, that will seem absurdly boring. For others, it’ll seem completely appropriate. For the rest, here are the answers to a few of the more obvious questions.
Why a student loan? The first place we looked when we found out that we were getting $1,800 effectively tax free was in the area of outstanding debts. The only current debts we have remaining are student loans and our home mortgage - since our financial turnaround, we’ve eliminated all of our credit card debt and our automobile loans, so we’re continuing the debt repayment process.
Why that loan in particular? Out of all of our outstanding loans - my sole remaining student loan, my wife’s loan, and our mortgage, her student loan has by far the highest interest rate - over 8%. It also has no prepayment penalties - something well worth making sure about before you make an extra payment. Thus, it was the obvious target when it came to paying down debt.
Why not save for a future big purchase, like that next car? Your truck is sounding ominous as of late… I already have enough saved for a nice down payment on any car we might buy next. Since I’m quite confident that we could get a loan under 6% on any car we might buy (based on advertised loan deals around here and my current strong credit), it’s more effective to pay ahead on that loan.
Why not build an emergency fund? Our emergency fund is plenty fat - all income could vanish for six months and we’d be okay.
Why not invest it? This was a second possibility that we strongly considered before deciding to pay down the debt. The biggest reason we decided against it is that the debt repayment is largely tax free, where we’d have to pay some tax on the returns from the investment. Another strong factor in favor of the debt repayment is the guaranteed return - with the investment, we’d have to take on some risk to hope to get an 8% return.
So what’s a “good” thing to do with my economic stimulus package? The first thing to look at is your emergency fund. How big is it? I usually argue on behalf of two months’ worth of living expenses in your savings account for each dependent you have. If you don’t have that, just put the cash in a savings account and hold it until an emergency does happen, like a car dying or a job loss.
If you’re covered at least reasonably well on the emergency fund - I recommend at least $1,000 for even thinking about anything else - focus in on the high-interest debts. I classify a high interest debt as anything that has an APR over 8%. Apply your economic stimulus check to these, with the check going to the highest interest rate debt.
If you have no high interest rate debts, then consider parking it somewhere for future expenses - a car, a house down payment, or something like that. If you’re beyond those needs, then look at paying off your remaining debts or investing it - you can’t really go wrong either way.
Shouldn’t I spend this money to buy “stuff”? After all, it’s an economic stimulus package, right? Do not spend the check on rampant consumerism. If you’re concerned that you’re not spending it and thus hurting the economy, consider this - if you’re spending it to repay a debt, you’re propping up a bank and also helping out your own credit situation, making it easier for you to make future significant purchases.
Remember, this economic stimulus package is going out to help the nation through a potential recession. The best thing you could do with it is to use it in just that sense - make sure you can get right through a recession as well so that you can face a bright sunny future on the other side.
The Simple Dollar chronicles a man's road to recovery from "total financial meltdown." As author Trent Hamm puts it, "The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two." We'll post a couple of entries a week, but you can check out his writing daily at www.thesimpledollar.com