Create a get-out-of-debt plan before baby arrives
By Erica Sandberg
January 21, 2016
I'm pregnant! I just found out! I want to pay off my debts before the baby is born. I need help, though. My debts total $14,000 — $6,000 is my car loan and the rest is split up between two credit cards. What should my plan be? Or should I save cash instead? My husband is on board with my decision to have the baby and to pare our debts. — Jaime
Congratulations, mother-to-be! I can't think of a better time to get your finances in order.
Paying debt down is a fantastic goal. Once you've done that, whatever income you have can be used for your current expenses plus the new bills that are sure to come. Once your baby arrives, you may not go back to work immediately — or at all — so if you are used to living on two incomes, you're in for a major adjustment. For all these reasons, you will need to maximize your cash flow — now and in the future.
Your car loan and credit cards are both important, but they are different products and need to be separated in a payoff plan. Car loans usually have very low interest rates compared to credit cards, and the payments are fixed. Currently, the average 60-month new car loan interest rate is 3.28 percent. The loan is secured by the vehicle, so if you fail to pay, the lender can repossess the car.
The average APR for a credit card is 15.12 percent. Credit cards enable you to borrow up to the credit limit, so as you pay a balance down you can charge more. The monthly payment requested by the card issuer depends on how much you owe at the time. In the event you don't pay, issuers would have to take you to court and win a judgment to claim any funds due.
I'm not implying that you can't or won't pay your bills, but it's smart to understand the differences between your credit cards and car loan.
Now to eradicate both of these obligations. Because interest rates are so much higher for credit cards than for auto loans, it makes more sense to tackle your card debt before your car loan. Use this five-step plan:
- Determine the total amount you can afford to send to your card issuers and auto lender by reviewing your income and spending habits. Whatever that amount is, stick with it until you're debt-free.
- Suspend charging while you're concentrating on repaying your debts.
- Send the biggest amount of available cash to pay down the credit card with the highest APR, the smallest amount to the other card issuer, and the fixed payment to the car loan.
- After the first card is paid off, add that payment to the second card.
- After the second card is paid off, add half that payment to the car loan and deposit the other half in a savings account. When the car loan is at zero, increase the deposits to your savings account.
I can't promise that all of your debt can be paid off in the next nine months as I don't know how much extra cash you have to apply toward it, but don't let that kill your momentum. For an extra boost, you or your husband may want to take on some extra work or sell stuff online to come up with some quick cash and apply those proceeds toward the debt.
Take the time to develop a fresh family budget, too. Consider what your family will be bringing in as income, then start to project for upcoming expenses, such as increased life and health insurance, child care (even if you don't go back to work and won't need help during the day, you may want to get out of the house for a date night every once in a while). Don't forget diapers, infant clothes and gear, such as cribs, high chairs, car seats and strollers. Include all these costs in your budget rather than borrowing for them.
To stay out of debt in the future, accept that you don't need all the baby items at stores. Most parents can get by with buying far less than what is on all those “essential” lists for a baby. Instead, ask friends who have had kids for advice and donations, buy used when you can, and add the rest to a registry (if you'll be having a baby shower). I promise that your little one will be just fine without the latest doodad, and you'll be a happier mom without the bill for it.
SEE RELATED: Couple buried in debt, with baby on the way
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