The size of your bonus isn’t nearly as important as how well you put it to work in your financial life, in order to maximize its value.
Here are a few simple tips to inspire you to use your bonus to pay off debt. Whether you have mountains of debt or a few lingering loans, there’s a strategy you can use to make sure your bonus works as hard as you did to earn it.
1. Focus on your most expensive debt.
Mathematically speaking, your debts with the highest interest rates cost you the most (especially when they offer no opportunities to potentially deduct interest payments and lower your tax liability, which can sometimes be the case with student loans or mortgages).
In fact, Bankrate explains that using your bonus to pay off debt for high interest rate balances (like credit cards) can result in an instant return on your cash that is often greater than what you’d earn by parking your bonus in a savings account, or even investing it in the stock market.
- Make a list of all of your debts. Include credit cards, personal loans, student loans and auto loans. Order them from highest to lowest interest rate.
- Use your bonus to pay the first debts on your list. You’ll instantly increase the value of your bonus by reducing what you pay in future interest charges, and you’ll free up more cash to put toward the rest of your debts.
2. Eliminate rising interest rate risk.
If you have variable interest rate loans, which could include federal student loans issued before July 2006, private student loans, student loans you refinanced or even a mortgage loan, your loan’s interest rate and monthly minimum payment could increase as interest rates rise.
Consider using your bonus to eliminate variable interest rate debt: You’ll reduce the risk that you could be saddled with debt that becomes more expensive (and takes longer to pay off).
3. Motivate yourself to get serious about debt.
Need some motivation that you really can conquer your debts? Use your bonus to pay off debt using the snowball method.
The idea behind this strategy is that by paying off your smallest debt first, you get the satisfaction of seeing at least one debt disappear entirely. As result, you’ll gain the increased confidence that you can consistently eliminate debt, if you take it one balance at a time.
4. Pay the debt you can’t get rid of.
Use your bonus to pay off debt related to any back taxes you may owe to the Internal Revenue Service, state or your local municipality. Not only does your unpaid tax bill keep climbing until it’s paid in full, also thanks to penalties and interest charges, it could also result in wage garnishment.
For similar reasons, consider using your bonus to pay off debt for federal student loans. As explained by Credit.com, unpaid federal student loans that don’t qualify for debt forgiveness or reduction cannot be charged off in bankruptcy. If the loan goes into default (becomes past due by more than 270 days), it could be turned over to a collection agency. That could result in additional fees, and could reflect on your credit report for several years. If you refuse to pay what you owe, the government could sue, garnish wages or apply your tax refunds to your student loan balance.
If you have to pay what you owe on federal student loans one day, why not use your bonus to pay down this debt?
5. Own your car outright sooner.
You don’t technically own you car outright until it’s paid for in full. That can cost you, even if you financed through a low interest auto loan. Once you own your car, for example, you have an asset that you could sell or borrow against in case of emergency. Plus, you may have more control over the type of auto insurance you carry (and what it costs) when you own your car.
Consider using your bonus to pay down your auto loan, even if you can afford to make just a few extra payments. Because you’re already in the habit of making the monthly car payment, you can seamlessly direct that same amount of money to build your savings, beef up retirement contributions or start investing, as soon as your car loan is paid off.