A financial windfall doesn't necessarily mean you'll be out of the debt woods just yet. Money Girl has the scoop on the best way to pay off your credit cards.
Tina wants to know:
"I was involved in an accident and have a lot of credit card debt due to my unexpected medical expenses. However, I’m going to receive a settlement. Should I pay off all the debt at once or make regular payments over time? I’ve heard making large payments toward credit card debt is taxable."
Debt is only taxable if it’s canceled or forgiven by the lender. For instance, if you owe $30,000 on a credit card and the issuer agrees to settle the debt for $20,000, then $10,000 would be considered taxable income.
When you pay the full amount of your debt, no tax is due—no matter if you pay it off over time or with a single, large payment.
How you should handle a windfall depends on your overall financial situation. Always pay off credit cards and other high-interest debt as soon as possible because the interest is costly.
However, don’t forget that you should have a minimum of 3 to 6 months’ worth of emergency savings to help protect you from unforeseen expenses or a loss of income.
So be sure to use a portion of your financial settlement to beef up your emergency fund if you don’t have enough saved. Keep your cash reserves in an FDIC-insured high-yield savings account where you can earn some interest and access the funds right away. Then send as much as possible each month to any remaining credit card debt so you can whittle it down as quickly as you can.
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