Do You Have a Financial Cushion?

It's wise to set aside an amount of money that will sit in your account at all times. This means if you are faced with a large unexpected cost you will have money available to pay it off, like last-minute travel to a funeral, a major fault with your car, or replacement of broken furniture. It's a “cushion of cash” for when your account balance falls.

But it can be confusing figuring out what your budgeting priorities should be. Should you save money for emergencies? Or repay your loans and credit? Once you decide to take control of your personal finances, you can be actively making decisions about where your income is best spent, and therefore deciding what to do with what's left after your living expenses are paid.

Step 1: Consolidate Your Debts

This process ensures you are paying the minimum possible for your debts. Depending on the terms of your credit agreements, it may be possible to refinance debts like your mortgage, car loan, hire purchase, student debt, etc. into a single debt with a more favourable interest rate.

If you have a credit card with a high interest rate, see if you can transfer the debt to a card with a promotional offer for balance transfers. If you qualify, some will charge 0% for 18 or 24 months.

Unless you don't have enough income to pay for your debts each month, don't agree to a consolidation loan that extends your terms, or you will end up paying more for interest. Try to pay the same amount per month that you are already paying, and if you are getting a better rate, the debt will be paid off faster.

Step 2: Pay Your Debts

Before you start to put money in savings, you should pay off your debts. The interest that you will pay on debts will almost always be more than the interest you earn on savings, so the frugal priority is to eliminate your debts as soon as possible.

Step 3: Create Your Cushion

If you don't have a financial cushion, then you may have to pay unexpected costs by borrowing money. Whether it is a personal loan from a friend, a credit card purchase, or going into your overdraft, it will add to your debt.

The size of your cushion can depend on your lifestyle. Think about the biggest emergency costs you might face (household, car, travel, etc.) and try to at least match this cost. Three to six months of expenses would be useful in case there is a sudden interruption to your income flow, to loan to a family member when they are in need, or if you are faced with several large, unforeseen costs at once.

If you have to spend your cushion, put your savings on hold until you have replenished the fund.

Step 4: Start Your Savings

What comes next depends on what's important to you. Some people save towards a new car, a family holiday, or a month long backpacking trip. Other people would like to own a home. ISAs often offer the best rates for savings as the interest you accrue is tax free within certain limits. Some types of ISA will even offer incentives for spending these savings on buying your first property.

It's also wise to start saving for your retirement as soon as possible. Depending on your type of employment, you may be able to pay into a workplace pension. These usually offer the best rates, but personal and stakeholder pensions are also available, so it's worth comparing. The one that's right for you will depend on how much you can afford to contribute and how much risk you are willing to take with the money. Also be wary of charges and the terms regarding moving to other pension policies.


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