Dear Debt Adviser,
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I received a large bonus, and I'm wondering about the best strategy to increase my overall financial stability. I could pay off my credit card debt of $20,000. But I also want to build an emergency cash fund, and I need to buy a car because my current one is on its last leg. What should I do?
Dear Red, I think you already know what to do. You need all three to achieve stability, right? I'm pleased that you want to get beyond your current needs and plan for what is always an uncertain future. So, let's get started on a plan.
First, develop a comprehensive budget. Financial stability starts with knowing where your money is going. Without a plan, you'll be leaking money every day without knowing it.
Then, I'd put the credit cards at the back of the line and deal with your emergency fund and car loan. These will help with long-term stability. Just paying your cards down will help for today, but not for the future.
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Let's talk about your emergency fund. Try to save between six and 12 months' worth of living expenses. If you set aside one-third of your bonus, about $6,600, for an emergency fund, you'll have a good start on that goal.
Next, I want you to begin thinking about cars that are new (or with a warranty), reliable and inexpensive. I know, that sounds boring, but this is only temporary while you are on the road to financial stability. Once you are there, you can afford to splurge a bit on better wheels. For now, remember that carrying more debt than necessary won't help in your drive to stability. So the smaller the car loan, the better. That means you must buy an inexpensive car and/or have a sizable down payment.
Make sure to pick a car that holds its value. Many people owe more on their car loan than the vehicle is worth. That can be trouble if their financial situation changes and they can no longer afford the payment. I also recommend that you use no more than a third of your bonus to secure your next vehicle. If you secure a loan for the car, be sure to include a down payment of at least 20% of the purchase price.
Now, let's talk about that credit card debt. I suggest paying down your balances with the last third of your bonus. And be sure to include in your budget a monthly payment that you can afford. Then, promise yourself you will not add to the balances unless you can pay it in a very short period of time.
Although the timing on the bonus was great, don't count on another one. If you work your plan just right, you won't need one.
Copyright 2012, Bankrate Inc.