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Target your toxic debt

Feb 01, 2010 | | Comments Comments Off

Dear Liz: I am a single woman with a base salary of $101,000 plus bonuses, which so far have been significant. I divorced three years ago, and I am still digging out of debt. Last year I put all of my bonus toward debt but still have about $20,000 remaining. I will soon get another bonus of $38,000 before taxes and 401(k) contributions.

Is it wise to just pay off all the debt, or should I target the higher-interest-rate loans and put some in savings? I am thinking that I would have just enough to eliminate all my debt except my mortgage.

Answer: Debt comes in three basic flavors: toxic, good and neutral. Toxic debt includes credit card debt, payday loans and other high- or variable-rate borrowing. Good debt includes borrowing that can help you build wealth, such as a moderate amount of mortgage or student loan debt. Neutral debt includes everything that’s not actually toxic but that isn’t helping you build wealth, such as fixed-rate car or personal loans.

You should get rid of toxic debt as quickly as possible, so use your bonus to pay off any that you have. Then consider any neutral debt you owe. If you already have substantial emergency savings, you could pay off that neutral debt. If, however, you don’t have an emergency stash equal to at least three months’ worth of expenses, and your neutral debt has low rates, consider building up your savings instead.

Finally, make sure to review your spending and saving plans to make sure you’re living within your base salary. Bonuses are great but are variable by their nature, and you don’t want to count on them to pay your bills or bail you out of a jam.

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Categories : Budgeting, Credit & Debt, Q&A