How to budget by prioritizing expenses

Prioritizing expenses can reduce the cost of debt while also maintaining essential services needed for day to day household functioning. Knowing how to prioritize expenses can also help ensure adequate retirement planning and avoid having important services cut off.

In order to prioritize expenses, it is important to first have a budget that assigns portions of money to the expenses before they are paid. This budget can help maintain consistency in financial planning and facilitates the prioritizing of expenses.

• Utilities and insurance

Without utilities and insurance, living becomes difficult and potentially dangerous. Without the basics of day to day life, performing income generating tasks, and maintaining focus on other priorities is challenged. For this reason, it makes sense to first pay those expenses that allow one to function in such a way that other debt payments are more likely to be made or facilitated.

• Low balance accounts

A debt prioritization technique advocated for in the ‘Military Spouse Finance Guide’ is snowballing debt. This method starts by paying the largest amount to the smallest debt, then rolls over the funds used to pay that expense into the next largest debt. The theoretical affect of snowballing is with each consecutive debt that is paid off, a larger amount of money becomes available to pay off larger debts.

• Revolving credit

Revolving credit has a greater affect on credit rating than installment debt such as auto loans according to the Fair Isaac Corporation, paying down revolving credit such as credit cards has the greatest impact on credit score in terms of debt payment. Due to this, and the idea that credit cards often tend to have higher interest rates than auto loans and other types of installment loans, prioritizing credit expenses first can be a good idea.

• High interest debt

Naturally, high interest debt should also be paid. Even if it is just minimum payments, keeping this type of debt in check and on slow balance decline is useful in reducing overall debt and improving credit score. If this type of debt only constitutes a small fraction of total income and a large amount of total expenses, paying it off slowly helps maintain a credit history.

• Retirement expense

Saving for retirement may be put off and neglected for more immediate financial concerns. To an extent this makes sense, but eliminating retirement expenses from a budget altogether can be a bad idea. The earlier one starts contributing to a retirement fund, the less money is needed to include this expense among financial priorities so it makes sense to start early even if it means paying debt off more slowly.

Another key factor in properly prioritizing debt is managing new expenses. If the U.S. Bureau of Economic Statistics is a valid indicator, the U.S. national saving rate ranged between approximately one and seven percent between 2004-2010. This means a high rate of expenditure is prevalent throughout the country and that prioritization of debt can be helpful.

In light of national savings levels, new expenditures might best be avoided in order to lower debt to income, and credit to credit limit ratios. Since many people have higher debt and credit ratios, the task of prioritizing debt is made more difficult. However, if no new expenses are taken on, and expenses are less than 99 percent of total income, the prioritization of expenses can be beneficial when budgeted for accordingly.