It doesn’t happen very often, but once in a while in life, we’re presented with a lump sum of cash for some reason. Sometimes it’s the result of a class action lawsuit, a personal injury settlement, an inheritance, or it might be a payment on property damages or simply a gift. Regardless of the source, if you suddenly find yourself with a large lump sum of cash from a windfall, it can be really tempting to blow it on a big shopping spree or luxury goods. It is a much better idea to take a step back and spend windfall money wisely, to improve your financial position, and here, we will take a look at some of the best ways to do that.
What you should pay off first with your windfall cash depends on what kinds of debts or expenses you have. Let’s start with debt.
Your highest interest debt should always be the first place to stash your cash and trim down what you’re paying in interest over time, because this is money you are losing and you might not even realize how much it adds up. It doesn’t matter whether it is debt from a loan or a credit card, the most important kinds of debt to pay off are the ones charging the highest interest.
Pull out all of your bills and statements and see who is getting the biggest chunk of change from you each month. If you have a lot of credit cards and loans, it can be helpful to make a simple chart to get to the bottom of how much you can pay off right away. Don’t forget to include any annual fees or other charges when tallying up your costs.
One of the next best ways to use a windfall lump sum of cash is to wipe out long-term debt, or debt that may have a lower interest rate but that you will be paying over a long period of time, like student loan debt or a mortgage. While the debt may not cost a lot in interest each month, the amount you lose will really add up over time.
It’s pretty well-known that making one extra mortgage payment each year can cut down the length of a mortgage significantly, so making a big lump payment on your mortgage in addition to your regular payments can really be rewarding over the long term.
4 Ways to make life easier
Would life be easier without a car payment each month? If you have enough money from your windfall to pay off your car, do it. You’ll free up money you can invest into a 401(k) or other savings account, even as vacation money. Just remember that of any payment you wipe out each month, at least some of that money should be reinvested into some kind of interest-bearing account if you really want to put yourself in solid financial shape.
1. Prepay your rent
If you’re renting your home, then prepaying your rent may sound like a great idea if you’re happy with where you are living. Going this route may sound like an easy, no-brainer, but as is often the case, the devil is in the details.
Paying forward on your rent has to be done carefully and with a legal agreement that will protect you, especially if the ownership of the property changes or if the property is damaged. If your rental is managed by a well-run, professional management company with a good reputation, then pulling this off may be easier, but you’ll still want to seek legal advice and have any contract reviewed before signing and making that big rent payment.
2. Open a savings account with a goal
A better idea could be to set up a separate interest-bearing account used to pay rent only and establish direct deposit terms or some other form of automatic payment (if possible) if the goal is to not have to think about the monthly bill. You’ll earn a little bit of interest, have access to the cash if needed, and you’ll be able to use the money for moving expenses if the rental terms go sour or if the neighborhood heads south.
3. Why you shouldn’t use it as a down payment for a house
Using the money as a down payment on house may also seem like a good idea, but not if you have a lot of other outstanding debt. You’ll be much more likely to get approved for a mortgage and get a much better interest rate if you lower your debt-to-income ratio. By going back to basics and paying off your highest interest debt first, you will improve your debt-to-income score, and you’ll free up money each month in lower payments, putting you in a better position to save for a down payment. Having money in savings can also improve your debt-to-income ratio, and ultimately, your credit score.
If you still have money left over after making the most important payments, then it’s time to take a look at other necessary expenses that may not cost money in interest, but are costing more in other ways.
4. Prepay car insurance
Car insurance, for example, is usually cheaper if it’s paid annually. Most insurance companies charge extra fees when payments are broken up into quarterly or monthly payments, and life is easier with one fewer bill to pay each month. The savings gained by paying off your auto insurance might not be huge, so make sure you are looking at other areas first to reduce the amount of money you are losing to fees and interest.
If you have enough windfall money to get out of debt completely, then do it. Then you can get in the habit of only spending only what you can pay off in a short period of time with credit cards in order to keep up your credit score.
Shirley is a staff writer for MyBankTracker who covers personal finance trends, money habits, mortgages and foreclosures.