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Dear Penny: We Have No Savings. Should We Pay Off Debt With a $15K Inheritance?

Robin Hartill, CFP®

by Robin Hartill, CFP®

Senior Editor

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Dear Penny,

My husband (57) and I (50) need some advice on some next steps regarding a small inheritance we are about to receive. We both have 401(k)s and he has an additional pension, so our retirement savings is in OK shape. But other than that we do not have emergency savings. 

We have about $10,000 in credit card debt, one car payment, a mortgage and household bills, so we are basically living paycheck to paycheck. We do make more than the minimum payments on our debt and are slowly chipping away at it. However, one unforeseen emergency and all the progress we have made would be wiped out. 

My father-in-law passed away, and we will be getting about $15,000 in inheritance once the estate is settled. We have about $6,000 of home repairs that we need to make, leaving us with around $9,000. 

My question is: Are we better off using all the money to pay off our credit cards, or should we keep some of the money to start saving while we continue to chip away at our debt?

-K.

Dear K.,

I vote for going 50/50 here. Put half in an emergency fund and the other half toward your credit card debt.

That’s not quite as satisfying as seeing most of your credit card debt wiped away. But having $4,500 in a savings account at least gives you some cushion so that you wouldn’t have to sink deeper into debt or withdraw from your retirement funds in an emergency.

That will leave you with credit card debt of around $5,500. Keep making payments of at least the amount you’re currently paying so you can whittle away at that debt faster. I’m a proponent of the debt snowball method, where you focus on the credit card with the smallest balance first while making minimum payments on the others. When you finish paying one card off, you focus all your efforts on the card with the next smallest balance until you’ve paid off all your cards. Since car loans and mortgages tend to have much lower interest rates than credit cards, stick with paying the minimums on both for now.

After you’ve paid off the credit card debt, start putting all of the money you were spending on payments toward your emergency fund. Aim to build at least a six-month emergency fund. That can sound overwhelming when you’re starting from scratch, but you’ll make much faster progress when you’re no longer bogged down by credit card debt.

Once you have a sufficient emergency fund, you can decide whether you want the money you were putting toward credit cards to go toward your other debt. If the interest rates on the car loan and mortgage are low, it’s fine to make minimum payments and use the extra money to save more or simply enjoy life.

Robin Hartill is a certified financial planner and a senior writer at The Penny Hoarder. Send your tricky money questions to [email protected].