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With 2018 coming on quick you may be making some new years resolutions – things you’re planning to do to be healthier, to be more successful in your work, or to improve your personal relationships. All of those are great, and we wish you good luck in achieving your goals. But the new year is also a great time to resolve to improve your credit profile, and your personal financial situation in the new year.
When January arrives so does the season of paperwork: your employer will send your W-2, your mortgage lender will send a 1098, any business (or person) you’ve earned income from (that doesn’t employ you) may send you a 1099. Other assorted entities may need to send you paperwork too so you can complete your federal, and potentially state, tax return, and you may be using this opportunity to review your expenses from 2017 that you used a credit card or debit card for payment (or simply kept the paper receipt). Take a moment to look at some of these documents and receipts besides just getting the forms filled out and it may give you some insights into creating a more financially secure situation even if your income isn’t going up.
Set Up Automated Payments
A key to maintaining great credit is making your payments on time. Your creditors don’t just report the amount of your last payment to the credit bureaus, they also report whether it was on time or not, so even if you always pay in full but do it late, your credit score could still be negatively impacted. Additionally, many creditors charge late fees that can be quite substantial, so you want to avoid those. The best way to do this is to set up automated payments on as many of your credit accounts and subscriptions as you can. This is usually pretty easy to do, and can ensure your credit, and wallet, are not negatively impacted by late or lost mail or just having something come up that keeps you from manually paying your bill.
In the case of credit cards, you may not want to set it up to pay in full, but if you set it up to pay at least the minimum, then you’ll be assured of making a timely payment that will be reported to the credit bureau positively, and enable you to maintain, or boost, your credit score.
Use Your Bonus Effectively
If you’re lucky enough to work somewhere that provides a year-end (or “Holiday” / “Christmas”) bonus, even if it’s paid in the early part of the next year after it’s earned, make the most of it. Obviously, if you’re planning to use it on a big purchase, and using that money prevents taking out a new loan or racking up credit card charges, that’s fine. But if you don’t have a specific plan, take a look at using it to pay down existing debt. You might even want to consider this over investing the money. Here’s why:
- The S&P 500 index grew about 18% in 2017. It might do it again in 2018, but obviously it may not. Most credit cards have rates more around 14%-22% now, and so even if you’re on the lower end of the scale with your card you know you will pay 14% interest on the balance, but you have no idea if the money invested in stocks will actually return more than your credit card interest rate.
- If you only have lower interest loans (like a mortgage, auto loan or personal loan) you still may want to consider making an additional principal payment on these loans – it will still reduce the total interest paid over time.
Make the Most of Your Tax Refund
Similar suggestions to making the most of your bonus apply if you will be getting a refund from the federal government or your state government for over-payment of taxes through your withholding. If you have a specific plan for spending it, great, but if you’re not sure what you will do keep in mind that paying down debts may have a more effective return than investing or saving the money, as described above. Also, while the federal tax system for 2018 will be dramatically different than the last 30 years, if you have been usually getting a large refund year to year, but not much change in your income level, you may want to consider changing the amount that gets withheld from your paychecks. Then you can take that extra take-home pay month to month and keep your debts in check and maintain a good level of savings as well.
The Benefit of Paying Down Balances
An important thing to keep in mind if you have installment loans you want to pay down that paying down your balance is not the same as pre-paying your monthly payments. For example, if you have a loan with a $300 monthly payment (such as your car loan or a personal loan), and you got a $3,000 bonus or tax refund you can’t send in $3,000 and then skip your next 10 payments. The bad news is that it doesn’t work like that (in general, but check your contract and ask your lender). The good news is that paying down your balance and then continuing to make your regular monthly payment will pay off your loan even earlier (instead of being able to skip 10 payments you’d likely pay off your loan 12-15 months early), and also lead to paying even less interest as well.
If the borrower sends in an additional $3,000 with the standard payment then the loan will pay off 13 months early (and the last payment will be for less than the standard amount too), and the total interest paid after the principal pay-down will be just $1,400 for the remainder of the loan. So this $3,000 used to pay down the loan balance will provide $800 in savings, which is like a 27% total return (achieved over approximately 4 years).
As mentioned, the one downside to this is that your goal is to use the one-time boost from a bonus or tax refund to reduce your ongoing payments it generally cannot be done by paying more once. If your goal is to reduce your payments, you may want to refinance your loan, which creates a new installment loan and therefore a new payment schedule and amount. You can refinance other loans besides a mortgage, including a car loan and personal loans. We’ll cover this in more depth in a January article.