4 signs that you are paying too much debt
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Whether you have bad credit card balances, student loans, or a mortgage, paying off your debt is a good move of money that almost any financial expert would recommend.
When you allocate a certain amount of money to pay off debt, you save money in the long run by paying less interest over time while creating greater financial security.
However, when prioritizing your mortgage or loan repayment, be aware that there is such a thing as paying too much debt. Spending extra money to reduce these balances can sometimes make sense, but not if it means giving up some financial cues like having an emergency fund or saving for retirement.
CNBC Select discussed with three financial advisors the signs that you may be spending too much money on debt each month. Here are the four red flags they ask you to pay attention to:
“You could be paying too much debt if you pay more than your required monthly debt payments, and you find yourself strapped for cash at the end of the month and / or the pay period,” says Kelly Welch, CFP based in Pennsylvania. and wealth advisor at Girard, a Univest Wealth division.
Making more than the minimum payments on your debt can be beneficial, but it is a red flag if it means that you have no wiggle room left in your budget to afford basic necessities, such as grocery.
Before allocating additional funds to pay off your debt, create a monthly budget that lets you see how much money you need to cover basic needs first. If you describe your monthly expenses and see that there is room to pay more on your debt, then you can do it knowing you can afford it.
A budgeting app can help
Aggressively paying off your debts – especially low-interest debts like mortgages and student loans – when you don’t have adequate emergency funds is another sign that you are spending too much on your debt. .
“It can leave you in a bind if you face a situation such as a job loss where you cannot withdraw the money from your house” Danielle Harrison, a Missouri-based CFP at Harrison Financial Planning, says CNBC Select. “You also can’t call your student loan department and ask for money.”
Paying off debt at the expense of building up an emergency fund can certainly lead to its own problems down the road. Speeding up your debt repayment can reduce the amount you pay in interest in the long term, but if you ever face a job loss, an unexpected expense, or an emergency in the future, you could find yourself in a situation. much worse without a proper cash cushion to fall back, argues Joe Lum, California CFP and wealth advisor at Intersection capital.
“Having liquidity gives you the flexibility to overcome these challenges until you are able to consider allocating excess liquidity to debt elimination or investment,” says Lum.
Conventional wisdom says to set aside three to six months of your living expenses in a emergency fund. While it might sound ambitious if you’re just starting to build your own, you can use the 50/30/20 budgeting rule to create a plan on how much to allocate for saving each month. As a rule, 50% of your after-tax salary should be spent on your needs (rent, food, insurance, transportation, etc.), 30% on your needs (gym memberships, restaurant meals, clothing, etc.) and 20% towards savings, or your emergency fund if you don’t have any at all. These percentages can vary depending on where you live and how much you earn, but they are a good guideline to consider when determining how and where to spend your money.
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If you prioritize paying off low-interest debt like your mortgage over investing, you might want to think twice. You might miss the opportunity to make more money on the stock market.
Financial advisers like Welch suggest putting more money on the stock market rather than paying off your debt faster. “If you pay extra for your debt but haven’t invested any money in that year, you may reconsider where that money is going,” Welch explains.
Keep in mind that this advice really only applies to low-interest debt. Mortgage rates are currently near their historic lows, so it is considered “cheap” financing. But the interest rate you’re paying on your credit card balance is probably in the double digits, way more than what you could earn on investments. If you have a credit card balance with a high APR, you should focus on paying off before you put any money in the markets.
A fourth sign that you are spending too much money on your debts: you are not investing enough in your 401 (k) to match your employer.
If you put all your money in to pay down debt and miss an employer, you’re essentially leaving free money on the table, Harrison adds.
Welch notes that another red flag is if you are withdrawing money from your investment accounts to cover an additional payment on your debt. It’s not great to take money from your future self to pay off your past debts. Think twice before making this move.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.