I’ve Paid For This Twice Already…

Frugal living and debt reduction tips for a better financial future. This is one family’s story.

July 24th, 2009

The Case for Debt Elimination Over Savings

Focusing energy on debt reduction (or elimination, as I like to term it) or savings is an ongoing debate, not only for society at large, but in my own life.  Once I started taking control of my finances, instead of just going with the flow and barely scraping by, I’ve prioritized different things at different times, and it all comes back to which is more important to me at that point  – eliminating debt or putting money into savings?

This seems like it should be a clear cut process with a easily defined answer, but it is not.  Every situation is different, and the factors that come into that situation will vary.  Instead of looking at a cookie cutter one-size-fits-all solution, here are reasons I’ve prioritized debt elimination over savings.  Later I’ll look at the other side of the coin – when savings is prioritized over debt elimination, and then finally, what decisions I’m currently making as well as the future of our financial life.

Debt elimination reduces obligations

The most dramatic and immediate affect of reducing (and eventually eliminating) your debt is reducing the amount of financial obligations you have.  The less you owe, the more of your money is actually yours and not promised to someone else.  The more decisions you actually get to make about your money that aren’t made for you.

Debt elimination has a snowball effect

As you reduce and subsequently eliminate debt, there is more money freed up in your budget that can be applied to remaining debt, producing a snowballing effect.  The more money put towards debt, the less that debt becomes, and if you keep building upon that, the path to debt freedom gets shorter and shorter.

Debt elimination makes an immediate difference

$100, $10, or even $1 paid towards debt is that much more you do no owe, that much more you are no longer paying interest on, and in some loan cases, can immediately reduce the amount you are obligated to pay in a month.  This is a difference that can be immediately felt in your monthly budget, and paired with the snowball effect can have drastic positive consequences.

Debt elimination frees funds for emergencies

Money that is not obligated to pay towards existing debt can be, if needed, used towards other events, emergencies, or obligations.  If you now have to pay out $800 a month vs $1000 a month, that $200 can be, if need arises, diverted to a pressing immediate need.

Of course, many of these reasons can be turned on their head and used to defend a position of savings over debt elimination.  Which is why the path to take is a uniquely personal one.  And Next time I will be doing exactly that – turning things upside down and seeing where that gets us.   I’ve been on both sides of this debate, and mostly somewhere in the middle.  Finding that middle ground that is the right balance for you is the trick.

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21 Responses to “The Case for Debt Elimination Over Savings”

  1. I totally agree. Right now I don’t have much trouble deciding one over another because it’s all the way to eliminate debt. When I get closer to be debt-free I’ll probably only have debts that have small interest rates (since I’m paying the ones with higher sooner)… then I should probably spent some time worrying if I should pay them or not…

  2. Good to see you back! I struggle with this all the time. It’s so straightforward when the debt is evil credit card debt at 20% interest, but now it bugs me to not have money stashed away in a savings account. I waver back and forth between wanting to pay off debt and wanting to save the money. I usually end up splitting it in half.

  3. I am all for debt elimination. Seeing the interest on my line of credit or credit card makes me crazy. I feel as if I am just throwing the money away.

  4. I struggle not with “savings” per se but with tax-sheltered retirement accounts. Giving up the 25% tax benefit the 403b generates immediately … and giving it up for life (since annual contributions are capped) pains me (though I am not, this year, for the first time in ages, maxing my contribution…).

  5. Debt elimination makes a lot of sense for high cost debt especially. And often makes most logical sense. But logic is not the only factor. If the person only takes on more debt once they pay the balance down the benefit is lost. And yes, this is not a logical next step but it happens far too often. So that is just a consideration that must be factored in.

  6. All these arguments makes sense. The less debt you have, the more cash available to save. Eliminating debt leaves you in a position to save more money and also to live better.

    IMHO, though, you need both, especially in an unstable economy: enough in savings to support you for several months should you find yourself unemployed, and a steady debt payoff plan.

  7. I agree with you in most instances with the exception of being in a job/position which may be eliminated in the immediate future. I think having cash reserves are imperative in this case. Paying one’s home, utilities & communication is necessary if you are going loose your job. Credit card companies can’t take your home away, but your mortgage company can.
    If possible, paying debt & saving would be the optimal way to go but it depends on each individual’s situation.

  8. We are just starting this journey. My husband closed his business one year ago and started back to work this month. All I can think about is Debt elimination and start saving. Great points and food for thought!

  9. If you have a basic emergency fund, crush the debt first– the interest you are paying is probably much higher than the interest you can earn.

  10. This seems to be more a matter of crunching numbers to determine whether it makes sense to save or pay off debt.

    In my own case, my only debt is the $62K remaining balance on my 6% interest mortgage. I have investments that are earning much less than 6% that i can use to pay it off.

    Here are the pros and cons of paying off my mortgage early.

    Pros
    1. Save up to $12K in mortgage loan interest if i pay it off now.
    2. Erase all debt so i can now more exclusively focus on retirement savings
    3. The “sleep well at night” benefit

    Cons
    1. Lose the mortgage interest tax deduction if i pay it off.
    2. If I sell taxable mutual funds to pay off the mortgage, take a likely loss on selling funds consisting of contributions made during a bull market.
    3. If i reduce my 15% 401k contributions to free up money to pay off the mortgage more quickly, i reduce the amount of money that enjoys tax-deferred status.
    4. I reduce my liquidity by paying off the house, altho i still have ample savings should i lose my job.

    From a strictly dollars and cents view, paying off the mortgage early wouldn’t make sense, according to what the “experts” say, in a more “typical” economic climate. However, the recession and the current unusually low interest rates changes all that, i think.

    any thoughts?

  11. “debt elimination reduces obligations” indeed it does!!! not only your time writing the check and mailing it, but it also saves that .44 each every month!

    i know it sounds silly, but it factors into my purchases. buying $8.80 worth of stamps each time hurts a tightly made budget. that’s about 1/6th of our grocery budget in a week!

  12. Back when we were in debt up to our eyeballs, we would apply every extra dollar to our credit cards until the balances were paid off. It was a real struggle, but the reward of having no debt was worth it.

  13. I’ve done this both ways at different point of my life, and from my experience paying the debt off is far superior. I’ve had periods in my not so distant past when I had 10K in the bank, and 20K in credit card bills.

    Right now I’m getting intense on paying off the last of my consumer debt (barring student loans – thanks law school) and keeping my emergency fund at the $1000 minimum. For me, what Dave Ramsey says is right, I am totally freaked out by not having more in savings so I’m working hard to pay off my debt and rebuild my savings account.

  14. The great thing about this debate is that no matter which you go, you are ultimately better off for it. If you pay off all of your debt – it’s great. If you beef up your savings account – it’s great. If you do a debt payoff / beef up savings combo – again – it’s great.

    Some will argue that you should approach it from a mathematical standpoint and do what makes/saves you the most money. Others will argue that you need to do what best fits your current life-status and that you should do what you’re most comfortable with. Either way, you will be better off for it in the end.

    The ultimate reward of being financial responsible is the options it yields. Those options may come in the form of a plush savings account, they may come in the form of a better night’s sleep, they may be the family vacation if you’ve always wanted, and so on and so on… The goal is just to get there – the route you take is a personal choice and really doesn’t matter as long as you get there.

  15. I think that in recessionary times it’s probably more important to squirrel away a substantial survival fund — at least six months’ worth of living expenses, maybe as much as the equivalent of a year’s net income.

    In normal times? A smaller emergency fund will suffice. Getting rid of debt should probably be the first priority when times are good and your job is reasonable safe.

  16. Here’s the coolest fact I discovered recently:

    Paying off debt that has a 12% interest charge is like EARNING 12%!!! Anyone with credit card or other debt (myself included) needs to have this as a mantra. Who doesn’t want to get a 12% return on their investment???

  17. I agree with doing both. The thing for me is to reduce my debt down to a level that my unemployment payments will cover if I were ever unemployed while saving enough money to have in case my a hail storm breaks my windshield and same week that I have to take the car in to the dealer for some emergency airbag fault light (true story). I say AMEN to the small emergency fund being there when I needed it since it saved me from adding to the debt. :)

  18. Ashleyd needs to figure out how to pay stuff online and avoid the stamp. I’ve got some ING Direct referrals if she wants to bank online and avoid buying stamps. (They will mail a check for you for free!)

    This was the pep talk that I needed after a month of binging on credit. *Must* *focus* *on* *debt* *payoff*

    Thanks!

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