Debt

If you’ve been following money cat’s financial order of importance, you should have a decent amount of cash piled up just about now. Now that you have an emergency savings started, let’s start paying down debt!

Paying down debt is arguably as important as saving if you want to start on the path toward financial stability. However, having the emergency savings will hopefully prevent you from incurring more debt when you need money but the stash is empty, forcing you to take on more debt. Therefore, we will place paying down debt at number 2, right behind saving.

Another important thing to remember is that paying down debt is a guaranteed return. Even though it may feel like your money is going nowhere when you pay extra on your debts, it will have a large impact on your net worth in the long run.

Types of Debt

Some types of debts are more important to pay off than others. Some types of debts are backed by an asset. This means that if you can’t pay the debt, there is something that can be sold to çover that debt. An example of this is a mortgage. Say you took out a mortgage of $200,000 to purchase a house worth $250,000. If for some reason you fell on hard times and could not pay the mortgage, the house could be sold to pay off the remaining mortgage if the price of the house was still equal or greater than the price of the mortgage. Some debts such as credit card debt have nothing that can be sold to cover the balance. If you went out to the bar every night and bought everyone a round of drinks on credit, you’ll rack up a large pile of debt quickly and there is no underlying asset that can be sold to pay off the debt. This type of debt is riskier to have than debt backed by an asset. Some debts have interest that is tax deductible which helps a bit. The table below shows the most common consumer debts: