debt elimination vs increasing savings the ongoing debate

March 13th, 2009

Debt Elimination Vs Increasing Savings – The Ongoing Debate

I keep hearing stories of how bad things are right now.  I have friends who have been laid off or had hours cut in their jobs, interest rates on savings accounts keep going down, and I have been purposely avoiding listening to news about the stock market.  Closer to home, I’ve had some of my various sources of part time income decrease as things are cut back due to less demand or less funding.  We’ve made a commitment to some savings goals for this year, specifically increasing our emergency fund and saving for a new-to-us car.  At the beginning of the year, I was optimistic that we’d be able to do both those things by halfway through the year and then focus on eliminating our last non-mortgage debt, my student loan.

But here it is, the middle of March, and with a combination of personal tragedies and less income, we’ve not made any progress on saving for a car, and the emergency fund is at about $1500 (goal of $2500).  The first goal still is to increase the emergency fund to $2500, which is my primary March and April financial goal.  But saving $10000 for a new-to-us car will not happen by June, and may not even be feasible in 2009.

Which makes me want with all my heart to change that goal #2 to “eliminate student loan debt” instead of “save for new-to-us car”.   This last non-mortgage debt is like an albatross around my neck.  I hate that I even have it, and I sincerely want it to go away.  Part of simplifying our life is to simplify our finances, and one less obligation to pay is another step towards that.  But of course, my head says “If the car dies, then you’ll just add another debt instead of getting rid of one if you’re not prepared.”  And with the country on such shaky financial ground, I should want, rationally, to hoard my cash at hand just in case things become even worse for us financially before they get better.  But instead, my heart wants to be free of this last non-mortgage debt and accomplish my debt freedom goal.

So my heart and my head are at war.  Until we’ve met the $2500 emergency fund goal, I can continue to let them war it out, and see which ultimately wins in the end.  Do you have a savings vs debt elimination debate of your own?

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30 Responses to “Debt Elimination Vs Increasing Savings – The Ongoing Debate”

  1. Think about it rationally – the interest rate on your student load is probably much lower than the interest rate you would get if you have to finance a new-to-you car. You’ll be kicking yourself if you ‘give up’ your low interest rate loan only to take on a higher one.

  2. Absolutely. I got a raise in January and wanted to open a Roth IRA. But given the current economic climate, I wasn’t really sure that was the best move (particularly since I already have a 401K that I give 5% to–which my company fully matches). I considered hoarding all of the extra money. Then I considered throwing all of it at my car loan or student loan. In the end, I decided that doing a little of both is probably the wisest. I opened the Roth and contribute to it each month and I make whatever extra car payments I can afford to make. Sure, I don’t get the satisfaction of seeing the car paid off super early or of seeing my emergency fund increase exponentially. But I feel good about not being single minded when it comes to my finances and I’m proud to have both saved money and less debt. Every little bit helps…both for savings and for debt.

  3. My interest rate on my student loan is 7% which is not really all that low. I am old and was before the crazy-low student loan interest rates. Our last used car loan was a much lower rate than that (4%).

    So, who knows.

  4. Absolutely torn myself. I’ve been snowballing my credit cards and keeping a small ($1K) emergency fund for a year but I am the lowest seniority person at a place that is facing layoffs in January 2010. I know I need to shore up my emergency fund *and* payoff my credit card but I can’t make myself do it.

  5. I can’t decide either and I don’t think there’s any way to know the “right” answer (until after the fact, of course). After debating the matter ad nauseum, I finally decided to split the money available for both goals (saving and debt) down the middle and pay just $50 more to whatever goal was most important to me on payday. I also like to put all my “luck” money (tax refunds, birthday money or whatever) into my EF. Might as well fight bad luck with good luck. Completely random, I know.

  6. One of the PF writers I trust most — Liz Pulliam Weston — says in “Deal with Your Debt” that you shouldn’t pay down things like student loans when you’re on shaky financial ground.

    Why? Because it’s money you can no longer access. If you pay down credit cards, at least then you have access to the funds again (in a way) if worse comes to worst.

    Now, my knee-jerk reaction is “No debt! Debt bad!” But I have to admit she has a point.

    If you’re worried about your car dying, then don’t lock your money away by paying down student loans. Especially when you consider what rate you might have to finance a new car at, in these times when credit is hard to come by.

    I say, keep saving for that car. Keep padding your emergency fund. If you get to the point where you can afford the car completely and no emergency has happened, then you can always skim some of the car money off to pay a chunk payment on the student loan.

  7. thisisbeth Says:

    March 13th, 2009 at 5:00 pm

    Would it help you to see saving for a new car as paying off a debt in advance? If you end up needing to get a new car in two years, you’d have a debt added. If you save now–or pay the debt in advance–you won’t be adding new debt then.

    I do like the consideration to divide your money both ways: half to savings for a new-to-you car, and half to debt. The loan wouldn’t go down as fast, but it would be going down faster than if all your money went to savings.

  8. Yeah, in your situation, it’s a conundrum. There’s a valid argument on both parts, i.e. saving up more for the “new” car vs getting rid of debt, so you could handle payments (and get a better rate) should you have to buy it before you have the cash on hand. I think you need to ponder how precarious your car’s health is at the moment and whether you realistically can put off buying for several more months. Only you and your family can decide that one. I DO think it will be a family decision with some potentially tough conversations. Do remember the student loan is potentially tax deductible, so the after tax lending rate is *slightly* lower. Then again, car loans are probably going to be at historic lows this year.
    If you had CC debt, now would be the time to kill it. Apparently a lot of companies (Capital One, AMEX, et al) are outrageously increasing interest rates and lowering credit limits. Eck.
    You are safe from this at least, having so effectively knocked out all your consumer debt!

  9. I just blogged about a similar version of this myself. I really want to get out of debt, and a car loan is standing in the way of that.

    But. My husband’s company is scaling back and has announced layoffs. We need to save all that we can in the short term to weather out this economy.

    Right now, having plenty of cash is more important than being debt free.

  10. I’m in the exact same spot. I have a couple of obligations (a car loan & a small Plus loan) that I could pay off right now, but I’m hesitant on doing so b/c it would exhaust my EF. I admit it – I’m kind of scared right now. Things aren’t looking very good at work and I’m getting married in three months. Having the EF is the only thing that allows me to sleep at night. So, I’ve been saving like crazy and letting my debt ride for now even though it goes against my normal way of thinking.

    I agree with the others though – Save for your auto purchase and put the Student Loan on a temporary stand by. I have been seeing some great deals on new car rates, but used car rates are a different story – they seem to be floating around the 6 percentile. As Jay previously mentioned, Student Loan’s are typically tax deductible so that helps a little with the high rate. The one thing I haven’t seen mentioned yet is that you can almost always postpone payments on a student loan in the event of financial hardship – you can’t do that with a car loan. Student loans are the best kind of debt to have during hard times for that reason alone.

  11. For our family, we’re keeping focus on the debt elimination strategy. My industry is shaky, but I don’t believe I’m in the cross hairs (but, I’m not naive enough to think that I’m completely safe). I justify my continuing debt-reduction based on my budget.

    If I lost my job, we could still pay our monthly expenses (shelter, electricity, food, transportation) out of my wife’s income. I believe that I would be able to generate some income while looking for permanent work that would help supplement my wife’s income during the transition.

    Of course, in my worst-case scenario I would probably ruin my credit (or at least ding the heck out of it). But, that’s alright. I’m okay with that. I would battle to keep that from happening. It would also give me incentive to bring in cash… quickly.

    Maybe I’m misguided, but I want my debt gone! That way I wouldn’t have to worry every five minutes about the whims of my company or the economy.

    I do want to add, however, if I knew for sure a layoff was coming, I would start piling up cash. I’m just saying I’m not going to pile up cash unless I’m pretty sure (75% likely) to get laid off.

  12. I really enjoy reading your blog. I am sorry to hear of all the unexpected events that God has brought into your life this year, but just think how you would be doing if you had not been able to pay off almost all your debt in the past couple of years.

    I was wondering though…do you need to save up $10,000 for a new car? Why not look for a very reliable “used” car? We only had one car for quite a while, but finally decided to bite the bullet and get another car. We were able to buy a “used” car from a friend from work for only $2,000 dollar (and paid cash). It is still running well now for the 2 years we have had it.

    Just a thought!

    God bless..and will continue to pray for you and your family,

    Jeremiah

  13. I wrestled with this as well a few weeks ago on my blog. I posted asking for advice, really, I just needed some support to convince me to do what I know that I HAD to do versus what I WANTED to do. I suspect the same is true for you so. You know what you need to do I think.

  14. My husband’s company is scaling back and he’s having to take furlough. We have several debts that we’re working on, but with only a $1,000 emergency fund I’m having a hard time sending extra payments when we aren’t close to paying anything off and ridding ourselves of a payment. So what we’re doing for now is parking the snowflakes in a savings account and after we see how the year unfolds we’ll decide what to do with it. I just prefer the security of having money available should one of our jobs disappear. How long could you make it with just one car if the saturn dies? We both work nearly an hour from home in opposite directions, and it would be annoying, but we could probably make it 6 months or so if push came to shove on one car. Maybe if you could determine how long you could go on just one it would give you an idea of what kind of cash you would need to come up with. If you have to have 2 vehicles and the saturn does die you may be more likely to spend more just to get another vehicle quickly and that would negate what you’d save on the student loan. Just some thoughts…

  15. Though I’ve saved up enough to pay the $21,000 second mortgage on my house (there is no first on it), in the current economic climate I’m hanging onto the cash. As long as I’m employed, the $169 loan payment is easily manageable. So, until things settle down enough that I can be sure I’ll still have a job a week from now or a month from now, I’m letting the savings double as an emergency fund. The economy pretty much mandates that we be prepared, as best as possible, for the worst.

  16. Interesting Suze Orman tonight. She touched a bit on different kinds of debt, and again noted that Student Loans are one of the few debts from which you can never seek relief, even with bankruptcy. However, you have no other debt, so you’re probably not in trouble. Again, you have to consider how precarious your car’s health is, AND how much you need to really set aside to purchase a replacement. I agree with Jeremiah and think you could find a decent car for 2-3K. Pro: cheaper insurance, Con: more potential PITA. Do some research and get an idea as to the current minimum price for an acceptable (to you) car. Then, set a modified savings goal for the “new” car and attack your last debt once you’ve set aside that MINIMUM needed.
    Just a thought.

  17. I agree with a number of the other posts, and figured I’d add my two bits to as a vote of support.

    I would do some more car shopping. Having just bought a used car and sold the old one, I think you can find something reliable for less than $10,000. Things seem to be a lot more hit or miss in the $2,000 range, but you should be able to get a pretty good car with reasonable miles for under $6,000.

    I would save up the additional for the emergency fund, then $6,000 for a car. After that I would save another $4,000. This $4,000 could be used on the car, but my plan would be that if I didn’t need it for any other emergency (such as loss of job), I would put it towards the student loan. Then start saving up another $4,000 and repeat. This helps you reach two of your goals more quickly and provides some additional cushion in case of emergency.

  18. debtheaven Says:

    March 15th, 2009 at 4:45 am

    I agree that you could probably get a used car for less than 10K, even just 5K. And you could probably get a loan for it at less than 7% interest. Both cars are old. I would save enough to replace one cheaply, while paying off the SLs. Then you can save for a better second car.

    Good luck, whatever you decide. I’m glad your mom is feeling better.

  19. debtheaven Says:

    March 15th, 2009 at 4:47 am

    Another thing: if you have a 2500 EF, you can always use part of it for a car if you suddenly need to, and then rebuild the EF.

  20. I’ve been wrestling with a similar problem. I too have an older student loan — at a fixed 7.25% interest rate. (I consolidated before the recent spate of interest falls, back when anything below 8% seemed like a huge discount.) I really REALLY want to pay it off and get that debt from around my neck. But I also want to go back and finish my bachelor’s degree (which should take maybe six months of online school) and I also want to save six months of living expenses so I can exit my current job and test-drive my dream of being a full-time self employed writer. I’ve been thinking the best thing may be to split efforts — take my pool of extra money for the month and divide it evenly between all three.

  21. I think debtheaven has nailed it!

  22. In a worst-case, SHTF scenario, you can always apply for a forbearance on a student loan – even if you’ve got cash reserves.

    This isn’t going to be a small recession. I know you hate that debt like nothing else, but you need to consider that there could very well be worse things headed our way.

    I really understand how you feel – the student loan is my very last debt, too.

  23. I’ve been debating about the new-to-us car, vs school debt. Since my car is still running good I keep thinking that it’s great to run it to the ground and pay high payments into my student loan. I only started paying it in November so I’ve been thinking it might be better to really eliminate my debt, but on the other hand…getting a new car could prove to be reliable and make for less worries. Ah!!

  24. Dunno the student loan rules where you are, but in the US you can do a ‘forebearance’ on a loan if you are in financial dire straits. Taking that into account, you should plump up your emergency fund to $2500. If something very desperate happens to you, you have the cash and you can ask for your student loans to be deferred with forebearance. That would be a very good strategy for you.

    The car loan is another matter. I think I would still top off your emergency fund and after that, make your car loan a bigger debt priority than student loan debt. Unlike a car, your degree does not depreciate to be less than the value upon graduation. :-)

    I hope all is improving!

  25. FWIW you can apply for a forbearance (delay repayment) on SLs, but interest accrues. You cannot discharge a SL in bankruptcy, unlike consumer debt.
    For you, PaidTwice, the ultimate issue may be how secure your family’s source of income is. If there were any chance of losing NECESSARY income, I wouldn’t even consider accelerating the paydown of the SL as (1) that $ is GONE forever, and (2) as others have said-worse case scenario- you can apply for a forbearance until the whole financial scene stabilized. Set aside money for a car, then becomes simply savings, available for whatever is most important.
    It’s interesting how onerous a SL can feel when it really has been just as significant an investment as the purchase of a home!

  26. I would go first for debt elimination before increased savings. The interest should be first compared here. If the interest of the debt is larger than the interest of the increased savings, then definitely debt elimination should go first. In most cases, especially nowadays, I believe that debt interest rates are far greater than interest of increased savings.

  27. kentuckyliz Says:

    March 22nd, 2009 at 2:41 pm

    Storm clouds on the horizon:
    Pile up cash.
    Continue to pay your minimums on your debts.

    Being a homeowner, in this economic environment, how many house payments could you make if you were laid off?

    Does that put a ball of fear into the pit of your stomach?

    It should.

    Pile up cash right now, until this economy balances out. I wouldn’t buy anything optional and repair/maintain what I have. Holding pattern.

    Then when happy days are here again, you have a big pile of cash and can make decisions about where to allocate it–loan, car, savings, a combo platter.

    In 2007-08 I was going through cancer treatment and my insurance company was kinda flaky so I was afraid of what kind of bills I’d end up with–or if I’d be in bad shape for long enough to go to LTD (60% of salary). So I piled up cash. Being sick and at home a lot reduced my gas, groceries, travel, entertainment spending. It all went to savings. I was a savings maniac. I was on the DR TMMO forums with a signature file status report on my savings balance, and I was tracking for the moment when the balance reached the amount of the student loan balance plus one month of EF. That moment coincided with completing treatment, working steadily, and the insurance company finally getting their act together and paying the bills. On March 19, 2009, I pulled the trigger on William D. Ford and kissed that student loan goodbye. No more debt! Never again!

    I set my ambitious 2008 goal as getting a six or at least a three month FFEF in place, even though it seemed a bit of a stretch. Well, it happened, though not how I planned.

    Now I have a four year FFEF and that is very soothing in this economy. Half of all American adults believe it’s possible that they’ll be laid off. My job is secure except for the fact that my workplace is state supported and the state is having an incredible budget shortfall crisis–so really, anything is possible.

    When happy days are here again, I will scale back to a six month FFEF and decide what to do with the other three and a half years. LOL

    I vote pile up cash and hunker down!

  28. We just replaced our car due to a wreck. It had a few good years left in it. So we spent a few weeks looking at new/used, pricing things out, checking reliability, and here are my thoughts:

    We have a kid, and getting stuck on the freeway during rush hour is not our idea of fun. So getting a really old, probably reliable car that might crap out on us in the next few years was not our goal.

    A good, reliable car for $2000 will be hard to come by. You can find them. I’d stick with Japanese – Honda, Toyota, Nissan.

    A good, reliable used car such as above-mentioned ones were available for about $6000-7000. These were 2001-2003 models.

    90% of the cars for sale locally (used) are 1998 or earlier. A little too old for us. We like to drive our cars for more than 10 years. I think the economy is forcing people to sell their 3rd or “extra” cars.

    Loans if you have decent credit are around 2.5 to 3% from Honda, for a new car. (We paid cash, bought new, and are hoping our 3 year old can take this car to college.)

    As far as $10,000, that’s about what you might end up paying for a dealer-certified used car that’s a few years old. Not necessarily a bad thing either. You are paying a premium, but often get some warranty. Our last (wrecked) car was of this variety.

    good luck.

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