Does The Economy Make You Want To Pay Off Debt Or Build Up Savings?
Editor’s note: I set this post to publish yesterday and made the classic “New Year” mistake of setting the date to 2008! When I looked this morning at my blog, I was confused as to why yesterday’s post wasn’t showing… okay, I found it. Heh.
When I started this blog, our #1 priority was to pay off our non-mortgage debt. We had quite a lot of it, and the minimum payments alone were a significant amount of our monthly budget. We saved a $1000 emergency fund to keep us from having to resort to credit card usage, and then systematically started debt-killing. First the credit card, then one student loan, then the car loan. Now, we’re left with a $10000+ student loan, and a minimum payment of $145 versus the over $800 minimums we were tied to just 18 months ago.
As the economy changes, and as our debt shrinks, I began to wonder if staying the course and focusing 100% on debt reduction was the wisest path. A $1000 emergency fund, at the time we saved it, seemed like a huge amount of money. It still does seem like a huge amount of money, as far as spending that much on one thing, but at the same time, the past few years, we’ve had several emergencies that were over $1000 out of pocket. We’ve been able to cover the difference with budgeted money or snowflakes we hadn’t spent on debt yet, but it showed me $1000 probably wasn’t enough for an emergency fund for us. And then my car tried to die for good (although for now we’ve stayed the inevitable), and I realized we were going to get ourselves into even more debt trying to pay off the debt we already have if we didn’t become more prepared for life happening.
Even without a specific issue looming, the economy seems more uncertain every day. Jobs that might have seemed stable are not quite so stable. Growth industries stagnate. It makes me want to hoard money and hide. Not that that is a good plan or anything, but the uncertainty around me makes me want to hoard and wait and try as much as possible to be prepared for anything.
Are you still aggressively paying off debt? Are you increasing your emergency fund? A bit of both, as our current course is?
January 9th, 2009 at 10:35 am
I had to change up my debt-repayment plans in light of what may be happening at my company – but finished paying off my credit cards just in time. Now I only have a car loan and a student loan, but I’m saving my cash for now, versus aggressively paying off my car.
I know I’m taking a hit on the interest for the car, but I’d rather have the cash-on-hand security if I lose my job versus have to depend on unemployment and run up credit card debt again.
January 9th, 2009 at 10:42 am
We have gone back and forth over this issue a number of times, being really aggressive with debt last summer and then saying all cash goes to savings, then paying off one card in a flourish to stay motivated. Right now we’re back to saving a mini EF and next month its aggressive on debt again with the plan to be CC debt free by the end of 2009!
January 9th, 2009 at 10:51 am
we were able to pay off three of our four credit cards in 2008 (actually, i’m just waiting for the third one to arrive in the mail — i’ve got the money ready to go). we have a decent emergency fund, so i’m still going to push to get this last card paid off. because i have a freelance income, we usually get a tax refund (it’s really hard to know what i’m going to get so we keep my husband’s withholding the same) and if we do this year, that will go for the card. i want that thing gone.
January 9th, 2009 at 10:54 am
While we are debt free and have a four month emergency fund, we are very aggressively saving (first for the 6 month fund and 2nd $12k for a new to us car).
Unless you have a debt with ridiculously high interest, I don’t see how having your debt paid off in a mostly one income household is much help if the breadwinner is laid off! With $1000 your spouse would have about a week to find a job! I find feeding my kids and getting the mortgage paid a much higher priority than company x or the student loan people getting theirs.
While the economy was sound, I think $1000 was fine – it was rare for people to get laid off. I think in this environment $1000 is a recipe for disaster (though obviously this depends on the industry you work in etc.)
My husband is a professor/dept head in a state university and I spent 10 years as an advisor/administrator for a top 10 university) and he’s seeing and I’m hearing about budget cuts that make the 2001/2002 stuff look like pocket change. There are talks of even laying off FACULTY (I’ve never even heard word 1 of that being possible in the past!) and encouraging older faculty to retire. This is all just entirely unprecedented.
I think unless you are in a very secure job you need to be beefing up savings.
January 9th, 2009 at 11:39 am
My hubby and I were just discussing this. We have one debt, an $11,000 student loan. We want it paid off, as it is a $300 monthly payment.
But, we have decided that growing as large an emergency fund as possible is the No. 1 priority.
We had a No Spend Month to jump start our savings,and we developed a budget for the first time ever in our marriage. So far, we are sticking to it.
I am sending a little bit extra to the student loan every month, and my goal is to send $3,000 in extra payments this year. But, the savings account comes first and only after that is fully funded (our goal is $500 to $1,000 a month), will we put more toward the loan.
January 9th, 2009 at 11:46 am
We’re doing a bit of both, but we have a sizeable emergency fund already built up. As soon as I get it o 6 months of salary, we’re throwing everything at the mortgage to get that over with.
We are also focusing on not buying anything unless we need it (which we’ve done for several years already). This will help us accomplish both of our goals much quicker.
January 9th, 2009 at 11:57 am
This is one I’ve been debating also. We are just getting started getting debt in hand so we still have a long way to go without even looking at the car and house.
Job security is not as big an issue at the moment (military) so I think we will continue to hit the credit card debt hardest…but maybe start putting some extra in the emergency fund a month just to make a little progress.
January 9th, 2009 at 12:26 pm
I would have to think you would want to get out of debt. To me that seems like wasted money being spent on interest rates. The goal to be getting out of debt quickly so you can fully concentrate on building savings.
January 9th, 2009 at 12:57 pm
My number one priority would be to save as much as you feel comfortable to have an EF and then start up your retirement again – the simple fact is, the compound interest you are losing more than makes up for the “good feeling” of paying off your debt. I agree with the poster above that says “I need the money more than my debtors” Slow and steady WILL win the debt race…but you can’t EVER get that interest back in retirement earnings, especially in this market. Good luck!
January 9th, 2009 at 1:07 pm
I guess we’re lucky, in a weird way. My husband’s on unemployment and I’m on disability, plus doing some part-time contract work. So all of our payments are guaranteed, at least through May, when my husband’s unemployment will end.
So we’re focusing on paying down as much debt as possible while we can. If he can’t find a job before May, then we’ll have to live on about $1800 a month, compared to $2900 now. So then we might be in some trouble, but we’d at least be able to pay for our basic living costs and keep paying a little over the minimum payments.
It’s not ideal, but there’s some security in already being on the lower rungs of the financial ladder, I suppose.
January 9th, 2009 at 1:07 pm
Until the recession got bad, my husband and I were mostly focused on getting our debt down (the dot-com bubble burst is still haunting us, I’m afraid). We were also putting some money into an emergency fund and were hoping to get it up to a solid 3-month’s living expenses, but we weren’t doing it quite as quickly as we could/should have.
Well, when my husband and I started to worry about his job we decided to slow the debt payments to a little above the minimums and throw the rest of the money into our emergency fund. Between cost-cutting and diverting money to the EF, we did manage to get a solid 3 months and were hoping to get that to 8 months eventually (and we still hope to have that some day as our new standard).
Things are looking much better job-wise for my husband but we learned that we couldn’t get our mortgage refi without finishing the much needed renovations on our house. We’re spending a few thousand from our EF to finish those up. The really good news is that if we get the refi we want then we’ll get back the money we spent on renovations very quickly. With the new mortgage we’ll get to 1. transfer our debt to a much lower interest rate and 2. take some cash out to build that emergency fund back up.
January 9th, 2009 at 2:02 pm
Good question. When we saw things starting to head south, I switched to saving. I even took advantage of two offers for “balance transfers” at 0% where I had a huge line of credit. That $ now is sitting in a savings account until I have to pay it back. I am absolutely unconcerned about our FICO score (which did take a hit) since I figure the national average is tanking anyway. I am also paying minimums on debt, and stashing any extra $ we get. We are lucky to have low interest rates at the present, with our highest, unhappily, being a 7.75% parent/student loan for one of our kids. Everything else is less than 5%, so doesn’t bother me too much. This will be our plan for at least the next year. So far DH’s job is secure, but I take nothing for granted. I seriously think everyone needs to build up [at least] a 6 month nest egg.
January 9th, 2009 at 2:25 pm
My wife & I are still concentrating on paying off debt. But we also have had the conversation about whether its a good time to increase the emergency fund.
I think it comes down to whatever you feel is best for you.
January 9th, 2009 at 3:00 pm
My husband lost his job today (we knew this was coming for a couple of months). We have only mortgage related debt now – the mortgage and a HELOC. I’ve been paying substantially more than the minimum on the HELOC, but I’ll be cutting that back to just double the minimum while my husband is out of work. I’ll try to save as much as I can while he’s out also (we’ll cut WAY back – although we’re already pretty frugal – the next cuts will be painful ones) so that we don’t need to touch our emergency fund (6 months of savings for both of us out of work, so a year for just one of us).
I am glad we got our credit card debt out of the way – things could be way worse for us I suppose.
January 9th, 2009 at 3:42 pm
I read in one of those financial planning books (Crown Financial) that the first step is to save $1,000 in an emergency fund…which looks like y’all have accomplished! Great job.
The second step is to increase that savings to 1 month expense and pay off non-consumer debt.
The third step is to increase savings to 3 month expenses and pay off all consumer debt.
They recommended splitting the money 50/50 until you reached one of the goal, then put 100% till you finish that step.
Good luck with whatever you decide!
January 9th, 2009 at 4:18 pm
We have been following Dave Ramsey’s plan for three years now and in the beginning the $1000 was great and felt like enough. Now with things they way they are, we decided to stop paying extra on our last debt ($8800 left on it) and increase our EF.
My husbands job seems secure, but as he is the sole income earner in our home I just didn’t feel comfortable with only $1K. And while his company/job seem ok for now, we have heard of layoffs at other firms in the area.
We are aiming for 3 months worth of expenses in the EF for now and are almost there. After that we will re-evaluate whether we continue to increase the EF or go back to paying off the last debt. I must say that emotionally, it feels really good/secure to see that savings account balance increase.
January 9th, 2009 at 6:11 pm
It’s a difficult question, because, logically, you’re paying more in interest while you make an emergency fund. By the same token, though, having to take on more debt to pay for an emergency can be hazzardous to your psyche. We’ve been paying down debt as agressively as we can with only one income, but I wonder if I shouldn’t be socking away more in the bank. Of course, since I’m a wee bit paranoid, I’m wondering if I should have more in cash around the house, just in case things get REALLY bad.
January 9th, 2009 at 7:02 pm
Penny’s last comment hit a chord: we did major banking at three different “places” ING, BoA and Washington Mutual/whatever. We moved almost all our funds out of WaMu about a week before it went under, and have worried a bit about ING, though I *think* it’s OK. Our HELOC is at WaMu and that initially had us very concerned. We have since learned all contracts are being honored, so it’s covered. That shook us up though, as we had considered the HELOC our ultimate EF. We really did contemplate keeping a relatively large sum of cash on hand in case the sky fell; luckily the banking system seems to have stabilized. Insane.
I just think no one can consider their income source safe right now, and we should be prepared to live on savings. It is a fine line, though, because many will not become unemployed, rather underemployed and if you’re carrying a lot of debt THAT could be a real issue, as I think underemployment is going to be a longer, chronic condition. Bottom line: we gotta all live really frugally with NO NEW DEBT. Too bad sales at Saks are down
January 9th, 2009 at 8:26 pm
Currently we do not have any debt other than our mortgage, but our roof needs replacing and we will be needing to replace our car soon, so I am thinking ahead to the debt we will be in unless we figure something out.
It’s a hard decision to know whether to pay off debt or build up your emergency fund. Several years ago my husband was out of work for a year. Once the severance ran out, we lived on unemployment and our savings, enabling us to stay out of debt (and also the grace of our friends and our church).
The thing about debt though, is that you wind up paying so much more than you really owe over the long term, due to interest.
In our case, we would probably pay off our debt, and maybe put a little in savings.
January 9th, 2009 at 9:00 pm
Jay said…”we had considered the HELOC our ultimate EF.”
People used to suggest that to us…”open a line of credit and that will be your emergency fund” (or you can use your credit card for emergencies.) WRONG! Credits lines are being closed left and right. It used to be that banks would loan money to anyone, anytime. You can not count on that anymore. When you need money, there maybe no loans available. Better to have your own emergency fund. If you save up too much, then you can use it to pay off some of the old debt.
January 9th, 2009 at 9:07 pm
We’re in saving mode now. At both of my husbands jobs he’s been cut back in hours and consequently wages and we just can’t be sure that he’ll have a job in the next year, or even the next month. So we’re saving every dollar we can. We cut back all the extra expenses, no cable, cell phones, newspaper, and we’re left with the basics. It’s not easy when we still do have debt, but we’ll have much more debt if my hubby loses his job.
January 9th, 2009 at 9:35 pm
I am happy to be in a position where I paid off all of my non-mortgage credit card debt many years ago, and have not carried a balance since, so I have been placing money in a high-yield savings account regularly, in addition to putting money aside for retirement in my 401K. With the recession, I would say that subconsciously, I have been putting a bit more aside in savings, just to keep building it up faster.
January 9th, 2009 at 9:58 pm
kathryn, you’re absolutely right! We’re out of that mindset bigtime, We were concerned that somehow the HELOC would be converted into something unaffordable in terms of interest rate, since we unfortunately do carry a balance. Many, many folks as you know have been caught with their credit limit cut down to what they currently owe, with outstanding debt they were going to use the LOC to pay off. Luckily that isn’t our situation. We figured if they could cut the credit limit, they could also change interest rates. That hasn’t proven to be true, at least for us.
Heard a comment on the news today from a “talking head” who said a few years ago we (in the US) would spend 120% of our income; now we’re only spending ~51%. Interesting.
January 9th, 2009 at 10:25 pm
I’m trying to do both but it’s tough not to cut down on repayment and up my savings. I’m holding firm and hoping my income will remain steady (or increase!) long enough for me to finish paying off my non-mortgage debt and build up more savings. I seem to be revisiting this issue at least weekly, if not daily.
January 9th, 2009 at 10:45 pm
I’m doing a bit of both. I originally was only going to have a $1000 emergency fund (and I’m now half-way there), but I’ve also decided as of this month, to build up some funds for larger yearly expenses. This is my third month on a budget, so every month I do more refining of my spending and saving habits. I have a monthly budget for a few categories that will see large once- or twice-yearly expenditures (like car maintenance). Every month I budget x dollars. If I spend less than x, all money unspent will go into that category’s fund until it reaches my yearly quota. Then when I’m under budget after I build up the quota, 100% of that unspent money will go to debt payments. I just wrote a post on this subject actually!
I’m still just starting this process. I feel extremely secure in my job. I don’t know yet if $1000 is enough for real unexpected emergencies, but I doubt I’ll increase it in the near future. I really want to focus on paying down debt for a while before I increase savings past a $1000 EF.
January 9th, 2009 at 11:00 pm
I’m focused on paying off my car loan, which is the only debt I have right now. I’m very close- should have it paid off by March or April. After that, I’m working on getting my emergency fund up to 3 months expenses (I have about a month in it now) and also building up my travel fund, since travelling is something I enjoy and is very important to me. It’s the reason I try to be frugal- so I can spend money on the things that are important to me.
January 10th, 2009 at 12:23 am
Ha! I did the exact same thing with my first post of the year…and I didn’t figure it out on my own.
January 10th, 2009 at 10:14 am
I wrote about the exact same issue on my blog. I think you should cut back on the debt reduction, and start saving! The reason: if you get laid off, and you don’t have enough money in your emergency fund, you’ll end up using credit cards. Interest rates are rising, and that’s the riskiest possible debt to have.
http://monogamoney.wordpress.com/2008/12/10/save-or-pay-down-debt/
January 10th, 2009 at 10:36 am
My husband and I have a lot of debt. A lot. About $60k in school loans alone. Credit card debt isn’t so bad, but other debt is overwhelming at times. For most of the debt, the sooner we pay things off, the less interest we pay. In our minds, the less interest we pay now, the more we can save later. So we are extremely aggressively paying off debt. Yes the job market is unstable, but unless we pay off some of our debt, we won’t even make it a week on $1000. By the end of March (praying his job makes it that long — they just got bought out two months ago and the first thing the new company did was to lay off an entire HQ office and slash pay by 10%, starting immediately) we should have paid off all of our credit cards and one other small loan, freeing about $200 that we can put into savings. However, we’ve decided that if we use $100 to pay off other debt, and $100 into savings, it’ll help.
To make it clearer, our minimum payment is $75. However, we’re paying $400. If we were to make only the minimum, it would take us 22 months to pay off our credit cards. During that time we would pay over $1100 in interest — almost what the debt is in the first place! (We were idiots: 23.8% compounded daily.) By paying $400, we will pay off our card in three more months, and only pay $180 in interest. That gives us more than $850 in extra money.
We just started a class at church based on Dave Ramsey’s book “Total Money Makeover Workbook”. We also listen to his radio show here: http://www.daveramsey.com/tdrs/# . He is kind of a tough love kinda guy. He told one guy once to go sell his DVD’s and books and stuff to get his $1000 in savings. What good is your stuff gonna do you if you lose your job? If it’s really that important to you, you can buy it back later.
January 10th, 2009 at 10:59 am
BOTH! We have no debt other than the mortgage, which is scheduled to be paid off early in just over 4 years. Most of my paycheck goes to savings anyway. Now the plan is to make additional principal payments in what is left with our monthly household budget. At the end of the month I’ll write out a check for what we have left over and send it in to add to our prepayment. If anything happens to me or my spouse, not having a mortgage payment to worry about would be a huge advantage in dealing with rough times. I just remember my grandparents and they had next to no money, however the house was paid off (years before I was born), so they never had to worry about paying for a place in which to live (yeah, I know property tax, utilities, etc, but that can be dealt with).
January 10th, 2009 at 2:58 pm
Nothing less than 6 months EF would comfort me right now. You can always go back and pick up where you stopped at paying extra on that last bill. Also, you need to seriously be thinking about the Saturn not making it until you are ready to kiss it good-bye. Tucking aside for the possible events to turn bad is NOT hoarding — it’s prudent. You’ve been making some great choices these past 18 months. The fact that you are rethinking your path shows that you are begin wise in regard to the future. If I were you I’d increase me EF at this time.
Rita
January 10th, 2009 at 8:46 pm
Saving, saving, frantically saving!
My only debt is a small second mortgage (I converted the HELOC to a 30-year fixed-rate 2nd mortgage on my paid-off house, cutting the monthly bill and ensuring that it will never change). In 2008 my goal was to pay off that 2nd mortgage or to set aside enough in savings to be able to pay it off. As it became clear that the Bush economy would soon implode, I decided to keep the cash in savings to double as an emergency fund: if the worst didn’t (after all) happen, then I could pay off the loan and dispense with the small monthly payment. But if I needed cash, I’d have it: about a full year’s living expenses, in full penny-pinching mode.
I met the 2008 goal — gathered enough to pay off the loan and put it savings — and so far have not, despite being in the same pickle that Laurie describes (working for a state university threatening to lay off anyone still breathing), been canned. As long as I still have my job, I’m cutting expenses and putting every extra penny into savings. I’m also putting everything from my side business into savings. The credit union must be dee-lighted with me, since I’m fast filling up their deposit accounts.
Obama’s proposed tax rebate will go right straight into the same savings accounts. Save my job, restore the value of my home or at least cut my property taxes to reflect reality, and rescue us from a depression: then I’ll pay off the loan and promptly go out and start buying.
January 10th, 2009 at 11:44 pm
We paid off our debts this past year, but did not go down to $1,000. I felt much more comfortable keeping one month’s living expenses as our minimum instead.
January 11th, 2009 at 5:50 pm
I’m focusing on paying off things as fast as possible while still plodding along on our emergency fund. In my situation I don’t think it would help to just pay the minimums and direct the rest to the emergency fund. It might give me an extra month and, frankly, that’s not going to help when the credit cards are racking up interest at 20%.
I’m trying to generate more money and, once the debt is paid down, then it can go to the emergency fund. Of course, in part, our situation is a little different because our worst case scenario would have us move from the city to our rural place, which is fully paid for.
January 12th, 2009 at 8:53 am
What about the third alternative of using the current market crisis to find the bargains that will build your future wealth?
Why is it that we are so willing to shop for bargains EXCEPT in the the stock and real-estate markets?!
January 12th, 2009 at 11:29 am
I have next to no emergency fund right now, but I only have a couple of more (well, three at most) payments on my CC and I will be completely DEBT-FREE…so I’m taking the chance on having little savings at the moment and will be paying my debt off first!!! I should get a 1K bonus in March, plus my tax refund, both of which will go straight to the EF. And then the rest of the year I will aggressively contribute to the EF.
January 12th, 2009 at 12:15 pm
Well, wish we could have seen this all coming!
In the summer we bought a house – still under construction, our first mortgage and we are having a wedding in March, etc. LOL
We had also taken advice we got a lot for buying a house and we bought the most expensive (biggest house) we could get- yikes! Keeping in mind lending rules in Canada are much tighter. But we will have just about every penny allocated and now the economy has made it a tad scary for us. Every extra cent was going to go to debt but now it will be set aside for emergency. It won’t be much and if either of us loses are jobs we’ll go under. We have $1200 EF, and in 2 1/2 years after my car is paid off we’ll be in a totally different situation. Debt is scheduled for 5 year payoff.
I guess we’re in it for everything we’ve got!
January 13th, 2009 at 4:04 pm
My only debt for a long time has been my mortgage, with current balance of $67,000. I’ve been aggressively prepaying an extra $425 a month on that, but now the current economy has me scared enough to also be throwing $600 a month into my emergency fund, which currently stands at about $7,000. goal: $24,000, or 8 months worth of living expenses.
So after putting more than $1,000 monthly toward savings and debt, there’s not much left over, but i’ve been doing this for a while and i find the buildup in emergency fund very satisfying. I do have other taxable savings, but wouldn’t want to tap them in an emergency since i’d have to sell at a loss since they’re in stock mutual funds.
January 24th, 2009 at 12:16 pm
We are doing a bit of both. We are trying to save for the down payment and closing costs on a house and pay off my retail business debt and my husband’s student loans so we have more of our credit freed up for our house purchase.
We are first time homebuyers and are in a good position in this bad housing market. We have immaculate credit and were preapproved for a loan for a decent amount. However, when we did the math of what it meant going out each month, including estimated expenses associated with owning a home, we decided to put our target home price at 20% less than the amount we were approved for. This way we won’t be lying awake at night worrying if we can’t make the payment because my retail business hits a slump or if my husband gets laid off.