Key Takeaways
- There are actually ways you can use your expenses as leverage to help you pay off your debt and save more money.
- Developing a budget, paying your bills on time, and prioritizing expenses helps to gain clarity of your financial picture, keeps your expenses low and credit ratings high, and helps you build a strategy to best leverage your expenses to save money.
- Prioritizing your expenses helps you take advantage of tax levers that can ultimately help you save more money over time.
Leveraging your expenses can help you pay off debt and save more money. So what’s a lever?
When you see a teeter-totter at a playground, and you’ve got a heavy kid on one side and a light kid on the other, you see the imbalance that’s created. If you move the teeter-totter toward the light kid you see it start to equal out. When we think of a lever in financial terms, we are talking about all the tools we can use to lessen that financial load and actually use it to our advantage.
How do we use leverage in prioritizing our expenses?
- Develop a Budget. This will help you create a picture of what your expenses look like so you can see what money you have left to apply towards other expenses and debt.
- Pay bills on time. This helps to build your credit score, and higher credit scores lead to lower interest rates and ultimately lower expenses.
- Prioritize Expenses. Determining what you are going to pay down first can lead to different results, so it’s important to check all of your options.
Let’s use some tax levers in the following two scenarios to see how that works in leveraging our expenses.
You’re 32 years old and you’ve got the below expenses and extra money:
Scenario 1
You decide to place all $400 toward your mortgage expense every month. After the credit card and the auto loan are both paid off in 5 years without you putting any extra towards the payments, you take the money you would be paying towards them ($228 and $413 a month), and you put that towards your mortgage payment as well. Your mortgage is paid off in 10 years, at age 42.
Now, you take all of those payments you were making plus the $400, a total of $1,750 per month, and you decide to put that away in a tax deductible 401(k). Let’s say you are in a 25% tax bracket, so that allows you to put $2,333 away. That’s tax lever 1. It grows at 7% tax deferred over the next 18 years, until age 60, which is tax lever 2. That total growth is $1,070,000.
Scenario 2
You take the $400 extra a month and you pay down the credit card first. It is paid off in 18 months. Then you decide to pay down the auto loan with the extra $400 and the payment you were making towards the credit card of $228 a month, which results in your auto loan being paid off in another 18 months.
You’re now 35 years old, and you decide to keep paying the mortgage without putting any extra towards the payment. You take the $1,041 that is the total of what you were paying towards your credit card, auto loan, and the extra money a month, and you decide to put that in a tax deductible 401(k). In the 25% tax bracket, that’s $1,388, which is tax lever 1. You get a 7% tax-deferred return on that, so that’s tax lever 2. You get an additional mortgage interest reduction, and this is tax lever 3. At age 60, you have $1,240,000.
That’s a total of $170,000 more than Scenario 1!
This example shows how important it is to pay attention to how levers of tax and prioritizing paying off debt can make a huge difference down the road.
Until next time, enjoy.
Gary