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Maximizing Your Extra Income: Smart Financial Moves
Whether your income is increasing or you receive an unexpected windfall, having extra money in your budget is always welcome. The best way to use it depends on your financial situation, but paying off high-interest debt is usually a top priority. You can also use extra cash to build your emergency fund, save for retirement, invest, or contribute to other savings goals.
1. Pay Down Your Debts
Carrying debt can be costly, especially with high-interest balances. The average credit card annual percentage rate (APR) is over 21%, according to the Federal Reserve’s November 2023 data. The faster you pay off these balances, the more money you’ll save. For example, if you owe $2,000 on a credit card with a 20% interest rate and a $55 monthly payment, it will take about five years to pay it off, costing you $1,200 in interest.
Here are two popular debt payoff strategies:
Debt Avalanche
This method prioritizes the balance with the highest interest rate. Once that’s paid off, you roll the money into the next highest interest rate balance.
Debt Snowball
This approach focuses on the account with the lowest balance first. While you might pay more interest overall, the quick wins can help keep you motivated.
Paying down debt is crucial because it can improve your credit score. Your payment history and amounts owed make up about 65% of your FICO® Score. A strong credit score can make it easier to qualify for better loans and credit cards in the future, potentially reducing the amount of interest you’ll pay over time.
2. Build Your Emergency Fund
A common rule of thumb is to have three to six months’ worth of expenses saved for emergencies. This can cover everything from unexpected bills to periods of unemployment. If you have extra money, it could help you build your emergency fund and protect your financial well-being if the unexpected happens.
A high-yield savings account or money market account can be great places to keep your emergency fund. These accounts generally offer higher annual percentage yields (APYs) than traditional savings accounts, and you’ll have easy access to your money if you need it.
3. Grow Your Retirement Fund or Invest
Saving for retirement is always important—the longer your money is invested, the more time you’ll have to benefit from compound interest. Here are some ways to use extra money to strengthen your retirement savings. Just keep in mind that these tax-advantaged accounts have annual contribution limits:
Increase Your 401(k) Contributions
If you have a 401(k) through work, you probably make contributions through automatic payroll deductions. You can contact your employer to increase that amount. Try to contribute at least enough to secure an employee match.
Contribute to an IRA
An individual retirement account (IRA) can be a powerful tool for those who don’t have access to a 401(k). They can also be used on top of a 401(k) to boost your savings. You can open an IRA through a brokerage firm, bank, credit union, or mutual fund provider.
Use a Health Savings Account (HSA)
An HSA allows you to set aside pretax dollars for qualified medical expenses. Once you turn 65, you can use this money as taxable retirement income. HSAs are available to those enrolled in high-deductible health plans.
You can also funnel extra money toward other investments, such as opening a brokerage account to trade stocks, bonds, mutual funds, exchange-traded funds (ETFs), and other securities. Real estate investing, cryptocurrency, or other alternative investments might also be worth exploring.
4. Contribute to Your Savings Goals
Chances are you have other financial goals, such as:
- Saving a down payment for a home or car
- Funding your next vacation
- Starting a business
- Setting money aside for your kids’ college education
- Renovating your house
If you have extra money available, you might focus on one savings goal or spread your money across different goals. Consider keeping short-term savings in a certificate of deposit (CD), which typically offers better yields than other deposit accounts, though liquidity may be an issue. For near-future use, a money market account or high-yield savings account might be a better option.
The Bottom Line
Having extra money in the bank is certainly a good thing. The key is figuring out what to do with it. Paying down debt, building your emergency fund, and saving for retirement should be top priorities. Beyond that, extra cash could go toward other financial goals. What’s right for you will depend on your personal financial situation.
Strengthening your financial life is good for your credit too, especially if you’re paying your bills on time and keeping your debt balances low. Free credit monitoring with Experian is a simple way to stay up to date with what’s on your credit report.
For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you make the best financial decisions for your future.
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