A nifty little trick that can be part of your savings plan is simply this: once a debt is paid off, still treat that payment as a bill – but now direct that bill payment to your bank account, IRA, or employer sponsored plan.
Here’s how it works: Let’s say you have a car payment of $250 per month. You’ve worked hard to get the debt reduced and eventually (maybe even early) you pay off your loan on the car. What a feeling! Instead of allocating the money to be spent elsewhere, such as buying another car or spending it on other items you probably don’t need, consider taking that $250 per month and reallocating it to yourself. The easy thing about this is that you’re already used to paying it, you’ve already budgeted for it, why not pay yourself? Also, you can consider putting the payment to yourself on auto-pilot, meaning that the money goes directly from your paycheck or bank account to your IRA, 401(k), etc.. Psychologically, it’s a lot less painful (and physically easier) to have money sent automatically from an account than to physically have to write a check.
Another idea to consider is that, should you have additional debt after you’ve paid off your car, consider taking that “former” car payment and paying down the other debt that you have. There are few guarantees in life – one of them can be guaranteeing yourself a rate of return. How? The faster you pay down a debt, the less interest you’re paying. Take for example a car loan of 5%. If you want to guarantee yourself a 5% return on your money, pay that loan off as early as possible. Although you won’t see a 5% credit to your bank account like you would on a 5% savings account, you will feel the benefits of doing this when you’re done paying off a loan 2 or 3 or even 5 years early, and can redirect what would have been “interest” money to your lender, back into your pocket.
Sterling Raskie, MSFS, CFP®, ChFC®
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