How would you spend a windfall?
If you become the beneficiary of a windfall, it’s easy to consider it as ‘free’ money and spend it on luxuries such as clothes, holidays or a car. However, no matter what your financial situation, it’s important that you spend these funds wisely.
You might dream about winning the lottery and fantasise about how you’d spend the winnings, and it might be acceptable to splurge a little in this situation. However, faced with a smaller sum of money, it’s crucial that you take a more responsible approach.
Although the chance is relatively small, you could receive a sum of money through inheritance. You might also be lucky enough to see a large return on investments, receive a tax rebate or earn a lump sum from cashback websites at the end of the year.
When you come into some money unexpectedly, no matter how small, you should carefully consider how to spend it. Fail to take the right strategy and you’ll only regret wasting the money later on in life.
What would the average person do?
JP Morgan Asset Management asked a group of Brits to imagine what they would do when faced with a £15,000 windfall. More than a fifth of those surveyed said that some of the money would go towards a holiday, and over one-in-ten expect they would purchase a new car.
However, there were also some more sensible aspirations, with 43 per cent of respondents saying that they would save the cash, 21 per cent planning to invest their hypothetical cash, and 16 per cent claiming they would put a lump sum towards their mortgage.
Keith Evins, head of UK funds marketing at JP Morgan Asset Management, said:”We are a nation divided on how we would spend a £15,000 windfall, and it’s a case of head versus heart – long-term planning versus short-term gratification.”
Pay off your debts
The absolute best way to use a windfall or any ‘bonus’ cash is to put it towards paying off your debts.
Whether your extra earnings are in two, three four or more figures, you should always prioritise the clearing of arrears.
This is because borrowing is expensive – interest fees mean that you are paying to be in debt. Because the charge is usually a percentage of money owing on a monthly basis, you could save significant sums by lowering the balance sooner rather than later.
Interest you could earn by putting money in a savings account will be far outweighed by the amount it costs to be in debt. If you have savings and arrears in the same bank, the lender is effectively charging you to borrow your own money.
Prioritise your most expensive debts
If you owe money to different lenders or alternative accounts, you should always calculate which funds are the most expensive to borrow and prioritise the clearing of this balance. This tactic is known as ‘snowballing’.
This term is used because you make larger savings by tackling your more expensive debts, which can then be used to clear the next most costly debt and so on. As a result, you can save huge sums of money and get into the black far more quickly.
To determine in which order you should pay off your debts, make a comprehensive list of all the money you owe, detailing the debit balance and the charges which apply. Find out, in terms of interest and other fees, which arrears are costing you the most money.
Of course, you should always make the minimum repayments to every lender to avoid penalty charges, but by allocating as much as possible to your most expensive debt, your financial situation will improve much more quickly.
The exception to the rule
There is one exception to the rule when it comes to windfalls and debt: don’t pay off arrears if it would leave you needing to borrow more expensively. In other words, it does not make sense to pay off a loan only to be forced to take out a more expensive one.
If you are in an extremely tough financial situation, and you would need to rely on credit to pay for essentials like your rent, it could be better to use your windfall for these expenses. However, this is only applicable if you cannot secure a cheaper loan than what you already have.
Stef went through a Debt Management Plan with the help of Debt Free Direct and now writes articles to help people save money and hopefully avoid getting into the financial difficulties she did.