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Graduating with Debt? Here’s a 6-Step Financial Action Plan


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This month, thousands of graduates left college with diplomas in their hands and dreams in their heads. Unfortunately, most of those young Americans are also critically inexperienced in the area of personal finance—during a time when debt among young people is high.

Nonmortgage debt is up 15% from the previous year for Generation Z and 9% for Millennials, according to Experian's State of Credit: 2017 report. Further, the average student loan balance is at a record high of $34,144.

If you have to manage car payments, rent, credit card debt, and private and federal student loans—all while earning an entry-level paycheck—your financial situation can quickly become overwhelming. However, those still in their 20s have the potential to dramatically shift their long-term financial outlooks for the better with a just few informed decisions.

If you have multiple forms of debt and you're unsure how to balance paying them down with other savings and investment goals, this six-step plan will help guide you through the process.

Step 1: Turn on automatic payments on all your loans

The first thing you need to do is to make sure you're not defaulting on any of your loans. Missed or late payments will incur additional fees and damage your credit score, which can cause trouble for you down the road.

Set up the minimum monthly payments required by each of your lenders to be automatically deducted from your checking account. Doing so doesn't just keep you on track to pay of your debts; it also may qualify you for a small interest-rate deduction on your student loans.

If possible, set the withdrawal date as the day after your regular payday, so that you have little opportunity to spend that money on brunch and other discretionary purchases before your loan payments are deducted.

Once that is done, make sure you always have enough money in your account to cover your automatic debits. If you're regularly cutting it close, evaluate your spending habits to find ways you could spend less each month.

For instance, do you go to the bar several times a week with friends? Try cutting that down to once a week. Do you eat out every day for lunch? Bring food from home instead. Cooking and leftovers are your best friends when you're young and in debt.

Step 2: Set up a mini emergency fund

While paying down debt is your largest obligation, you need to make sure you have a little cash set aside if your car breaks down or you have to visit the emergency room. Put $500 to $1,000 into a savings account, and don't touch it unless absolutely necessary. We'll return to this fund in step five, so we can grow it into a more substantial safety net.

Step 3: Maximize your employer's retirement contribution match

After you've set up automatic payments on each of your loans, check to see if your employer offers a retirement plan with a contribution match. Generally at this stage of life, paying down your debts should be your first priority. However, contribution matches offer such significant returns that they can't be ignored.

For example, your employer may offer you a 100% match on the first 4% of your salary you contribute to your 401(k) plan, and a 50% match on up to 2% above this amount. That means that if you allocate 6% of your salary to your plan, you get an automatic 5% raise to stash away for retirement.

An automatic 50% or 100% return on each dollar you save is a much higher interest rate earned than the interest rate you're paying on your loans, so maximizing your employer match should take precedence.

However, if your employer doesn't offer a contribution match, don't worry about making retirement contributions for now. Paying off your debts is more pressing.

Step 4: Prioritize your debts by interest rate

Once you've maximized any employer contribution match available to you, you should pivot back to your debt. You've already set up automatic minimum payments on each of your loans, so you know you're on schedule to pay them back. Now it's time to get ahead of schedule.

Figure out which of your debts has the highest interest rate, and allocate any excess funds to paying down that loan faster than required. Every dollar you pay ahead of schedule converts to less interest you ultimately will pay to your lender, so even an additional $20 a month will help chip away at the principal balance.

If you carry credit card debt, this should probably be your first target. The average credit card interest rate is between 15% and 20%, and the average cardholder younger than 35 carries $5,808 of credit card debt. At such high rates, that debt could cost you more than $1,000 per year just in interest.

If you're in a similar situation, you need to tackle your credit card debt immediately. Additionally, you should consider setting aside your card and only using cash until your debt is cleared. When you resume using your card, commit to only spending as much as you can afford to pay off each month.

Once your credit card debt is paid off, take all the money you were putting toward that debt and allocate it to the loan with the next highest interest rate. This could be a car loan or a school loan from a private bank, which both tend to have higher interest rates than federal student loans.

As you pay off each loan and reallocate those funds to the next debt, your payments will grow with a snowball effect and your debt burden will decrease at a growing rate each month.

Step 5: Grow your safety net fund

Once your high-interest debts are paid off, you should resume contributing money to your emergency fund. Your goal should be to build a safety net equal to three to six months' worth of expenses, including your housing costs, utility bills, grocery expenses and any other regular payments you're obligated to make. That way, if you lose your job or have some other financial emergency, you won't immediately fall into debt.

Most experts would suggest you put this money into a high-yield savings account, so it remains liquid while earning a modest banking interest rate.

However, in this current low-rate environment, even the best savings accounts generate less interest than the average annual level of inflation—the rate at which your money loses its buying power over time. Because of this, you'd need to top off your fund each year to keep it at appropriate levels.

To solve this problem, some financial advisers recommend putting some of your safety net fund into a very conservatively invested brokerage account. Doing so can enable you to keep up with or even exceed inflation, while still being able to access your funds within a few days of an incident. However, if this is the method you choose, you should consider stashing 20% to 30% more than your target amount, in case you need to tap into it during a market downturn.

Step 6: Increase your retirement savings

Once your safety net is fully funded and you've paid off all high-interest debts, consider increasing the amount you contribute to your retirement plan. If you haven't been contributing up to this point, now is the time to start.

As a general rule, individuals should try to put 10% to 15% of their income into tax-advantaged retirement funds in order to have enough money in retirement.

If this benchmark is beyond what you can afford, don't forget that your employer's match can help you reach your target amount. If your employer doesn't offer a 401(k) plan, look into opening an IRA to start saving for retirement on your own.

If you've paid off all your debts and have excess funds beyond the 15% mark, contributing more will put you in more favorable retirement conditions and may even enable you to retire early. However, you should also consider other long-term savings goals, such as putting a down payment on a house or helping your own children pay for their college tuition one day.

The article, Graduating with Debt? Here's a 6-Step Financial Action Plan, originally appeared on ValuePenguin.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.





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