Should you save before paying down debt?

I love getting mail from PDITF readers. It makes me feel like I’m important, even though I’m really not. Well, it’s time we help another Debt Puncher out and share our two cents on his situation. His email says…

I just paid off the first of my 9 (yes…credit+retail) cards. It’s a huge achievement. I’m currently following the high-interest method to keep motivation high. My top priorities are:

*Paying off credit card debt
*Establishing a buffer in checking

Would you apply all your monies to paying credit card debt first or vice versa? Or set-up a plan so both can be achieved albeit at a slower pace. According to my projections, I can reach both these goals within a year.

Well, Mr. Anonymous Reader Guy, if I were you I would stop paying your credit cards, forget about savings, head to Vegas, and bet it all on black. Thanks for stopping by, hope I helped 🙂

Haha, I’m only kidding (unless you’re feeling lucky then GO FOR IT!). I’ll answer your question by sharing a little bit about my journey. As you may already know, I started my PF journey with $28,000 in student loan debt, and just a few hundred dollars to my name. Making the decision to save vs pay down debt is not an easy one. In fact, I wrote this post, this post, and this post about it.

Personally, I hated the idea of not having any liquidity. Dave Ramsey suggests saving up $1,000 in a checking account and throwing all discretionary income at your debt. It’s not bad advice, but it’s not what made me feel comfortable. I totally would have lost sleep knowing I couldn’t even write a check for next months rent if crap hit the fan. You can’t pay rent with a credit card so I needed to have money in the bank.

That said, I would not recommend doing what I did and OVER save. At one point I had $20,000 in the bank,  but only $17,000 in student loans (you can read about it here). If I could go back in time, I would give myself a swift backhand to the face for that one. I totally perverted my enthusiasm for saving and kept that student loan around longer than I should have. I was a very bad Ninja.

So my advice to you is probably going to be the most incredible advice you have ever heard in your entire life. Go get a pen so you can write it down. Ready? Don’t Drink and Bike, you might spill your beer. Oh wait, that was advice I gave to my alcoholic friend.

What I meant was, you should probably save some predetermined amount ($2K, $5K, or whatever) while making minimum payments on your C.C. But the second, and I mean the second, you’ve accomplished that goal, pay down those CC’s like there’s no tomorrow. It may not make the most financial sense to keep your CC balances a little longer, but if you’re like me it makes a lot of PERSONAL sense. Besides, it sounds like you are gonna knock out both goals pretty quickly anyway, so the difference in interest paid is probably relatively small.

That said, I realize I am only one voice in this PF world, so I’d like to turn the soapbox over to the PDITF readers and see what they would do. How much did you put in savings before attacking your debt? Anyone else out there like me and OVER save? How do you balance financial sense (paying down the CC ASAP) with personal comfort levels (saving up a decent chunk in savings)?

If you have any questions, comments, or just a funny YouTube video you want me to check out, feel free to shoot me an email.

26 thoughts on “Should you save before paying down debt?

  1. I gravitate to the opposite of what Debt Ninja does. I like my bank account as close to empty as possible. Feeling like I have no money makes me want to spend less. (I have a huge buffer which is I’m part of a dual income family and we can survive on 1 if need be, so I don’t feel like I need as much free cash floating around).

    I guess my advise would be to figure out what motivates you more, to see your credit card balance go down or your bank balance goes up. Plus, what would happen in the case of job loss..could you collect unemployment, move back in with mom and dad..figure out what you need for a buffer and put the rest towards debt.

    Good Luck.

  2. A lot could depend on how much CC debt he has and how much of a buffer he wants in checking. If there is a lot of debt but a stable job, I would tackle the CC first. If the job is stable, 3-4 months of expenses in checking should suffice. The longer he avoids repaying the debt, the more expensive the interest becomes. But if he can realistically accomplish both goals within a year, the point is probably moot.

  3. I went halfsies with mine. I focused on paying off my high-interest rate debt first, while putting a minimum into savings*, and then focused on savings while paying down my lower-interest debt at a moderate pace.

    *However, I always have a 1k buffer in my bank account (my mum having impressed upon me the need to always have first and last month’s rent accessible in case anything goes awry).

  4. You need a certain amount of money for emergencies or you will end up using your credit cards. New brakes for the car. Root canal (twice before I got dental at work!). Dying grandmother and you have to travel. There is always going to be something. You need to have enough that you can cover the bumps in the road without resorting to credit cards again or you are not really paying down the debt. Only you can decide how much that money needs to be. For me it would be pay all your minimums, and whatever extra you have spend half on debt and half on savings until you have that number that will cover the bumps. Then punch that debt in the face!

  5. Ninja I think you have 20/20 hindsight now, you know now you oversaved because you didn’t have major emergencies to use your savings on. I wish I could know what the magic number is for my savings, because right now I feel whatever I have is not enough.

  6. Ha! Well, I don’t have any GOOD advice, but this is what I’ve done…

    We have $2,500 in a savings account from wedding gifts. That money is dedicated as a “house fund,” but we both know if the crap hit the fan we could use it to pay for hospital bills or whatever.

    I’m also still in school, and even though I have rejected help from my parents in the past, I know that if I REALLY needed it, I could go to them with any emergency. And because we’re students, we live cheap. My expenses for the entire month only total $600 (including gas, groceries and bills). And I have massive job security because I work with family. I know that I’d have to do something really screwed up to get fired.

    All that being said, that’s why I chose to put all discretionary income to my debt. I do not have a dedicated emergency fund, and I don’t worry about it. I know the chances that something really bad will happen are slim while the chances that my debt will accrue interest is a 100% certainty. If you’re someone who worries every hour of the day about the worst case scenario, it’s important to have a small emergency fund saved up. I’m just not that person. 🙂

  7. I would save just enough cash to pay my rent for two months if I lost my job, and then put everything towards your debt. Some people are saying that you should have a cash buffer, but YOU’RE ALREADY IN DEBT. As long as you still have available credit on your cards, then those are just as effective as an emergency fund as cash. For example:

    I have $20,000 in debt @ 12% APR and $5,000 in an emergency fund –> one month later I’m charged $200 in interest. NET WORTH: -$15,200

    or

    I have $16,000 in debt @ 12% APR and $1,000 in an emergency fund –> one month later I’m charged $160 in interest. NET WORTH: -$15,160

    I save $40 in interest in the first month if I pay down an extra $4,000 in debt. That’s over $480 a year (because of compound interest). Now if my car breaks down and I have $3,000 in repairs, my net worth will decrease by $3,000 whether I pay for it from my emergency fund or with my credit card. I’d still be $40 better overall in the second scenario.

    The only value of an emergency fund to me is for things you can’t put on your credit card.

  8. i’m sort of in the same dilemna right now, with $10K in a few different savings accounts but with the remainder of my car loan, $8K, irking the crap out of me. it’s all i can do to not get trigger happy and transfer all of the money to pay off the loan. the only thing that stops me is knowing i’d have nothing else to fall back on if an emergency happened. so i’m hanging tight, but just barely.

    i would say decide what you are comfortable with, and it’d probably be a good idea to have some savings just in case, and then trim down your monthly spending. then take what’s left and throw it at the debt. you might get used to living without that money, so when the debt is done, you can just keep saving that money and build a bigger buffer.

    • Your situation is a little different because your car loan is probably at a much lower interest rate than credit card debt would be.

      If your car loan is sitting at something like 6%, you can reasonably assume that you can get an 8-10% return on that money in the stock market. In this case, you’d be better off putting that money in the market instead of paying off your car.

      However, the 8-10% return is assumed, while the 6% is guaranteed if you pay off the car.

      • all of that money is sitting at ING for liquidity purposes, so i’m hardly making anything on it. so really, with the loan being at 5.75, and my interest rate being at 1.75ish, i’m still paying 4% interest (with nothing to offset that). not quite ready to jump into the market yet!

  9. I would put away a few thousand for emergencies and then focus entirely on getting rid of that credit card debt. As a matter of fact, I would probably take on a second job to get rid of the debt on the other 8 credit cards.

  10. Like Kevin mentioned, it depends on the interest rates you have. Typically debt is double digit interest rates causing a large charge for carrying debt. Savings is less than one percent.

    I can see the point of having an emergency fund, but the more savings one has for emergencies the more expensive that safety net is in interest payments assuming they have debt.

    Math – Separated for those averse to such things,

    Ex: carry Savings
    $100 X .005 = $0.50 (half a percent is actually considered good for a savings account sadly, it doesn’t even break even with inflation)

    Ex: Carry Debt
    $100 X .14 = $14.00 (14 percent is probably on the mid to low scale

  11. When we were paying off our debt, and HAD to save concurrently in order to feel like if we were suddenly in need of a large sum of money for a repair or replacement or if I couldn’t work due to illness (no sick time), we had some money to fall back on, rather than dipping back into the LOC. It really comes down to a mind-game because it really doesn’t make that much difference whether you save $1000 for an emergency or pay off your debt with that thousand dollars knowing you might need to dip back into it if you have a money crisis. If you need to use $1000 it has to come from somewhere, right? It’s all about what lets you sleep well at night!

    Now that our debt is paid off, we’re in the process of building our emergency fund up to cover about 4-6 months worth of normal expenses. That way, if we cut back during a crisis, we could potentially stretch that amount to cover 8-9 months essential expenses. We’ve got a LONG way to go as we’ve only got about 3/4 of a month’s worth saved right now.

  12. I would figure out how much your total monthly expenses are(what it costs you just to survive.) Multiply that by 3 so you know what 3 months of expenses cost you. Once you have that tucked away all safe and sound in a savings account of some sort then you can attack the rest of that debt. *think chuck norris roundhouse kick* You just don’t wanna put every penny you have toward your debt and then get caught with your pants down and need some money for an emergency.

  13. To me, it makes more sense to pay down cards with everything you have. Yes, in emergencies, the balance goes back up. But why let thousands languish in the bank at 1% interest while your card companies are charging you double-digit interest?

    And, Ninja, actually in a lot of places you CAN pay rent with a credit card. It’s a new trend. But not a great idea unless it’s a real emergency because you get charged a decent-sized fee for using it. Still not as bad as check-cashing/payday loan places, though.

  14. Once you realize that credit is like a drug not to be abused, I would agree with Abigail. I look at my available balance with credit cards as a nice emergency fund. After all, if worse came to worse there is always bankruptcy >:)

  15. It’s going to be very specific to your situation. Personally I try to maintain at least $1000 in savings/EF at all times. There are some things you just *cannot* plan for – life happens. $1000 may not be enough to cover big emergencies, but I would feel better about taking $800 out of savings to cover an medium emergency than I do about charging up another $800 plus interest.

    When I started paying down my debt, I paid minimums until I got $1000 in savings. Then I set up a monthly transfer of $100 on the first of the month and looked at it like a bill – I cannot touch this amount. That way, my savings/EF is growing, although slowly, to provide a little extra peace of mind each month. Meanwhile, I’m still able to throw (X – 100) dollars at my credit card each month. I feel better about it I see both of my balances moving in the right direction, not just one.

  16. We saved up $1000 for personal emergencies, and my husband, who has a small business, saved $2000 for business emergencies. We’re paying off debt now, and when we’re done with that, we’ll put a lot more into savings. I’m definitely glad we have the savings — hubby has needed his business savings more than once due to equipment breakdowns at the same time that clients were slow in paying. I don’t think we’ve used our personal emergency fund, but it makes me feel much better that it’s there in case the car breaks down or the furnace goes out or something. I will be more comfortable when we have more in the emergency funds, but for now, we’re concentrating on the debt.

  17. We have one month of expenses sitting in a savings account right now. We are aggressively paying off my student loan. Before we got serious about being debt free, I had about $15,000 in savings. It totally stoked me out to have that much cash sitting freely in my bank account. I can’t wait to have dollars again!!!

  18. I’m another pf blogger than enjoys the financial stability that cash in the bank provides. Having said that, Mr. BFS and I did almost zero out our emergency fund a few months ago to pay off our last non-mortgage debt (his car loan) and we’ve already built it back up to $5000. If an emergency did pop up during the last few months, we did have about $3000 spread out in cash and we could have cashed in some stock, but thankfully it didn’t come to that.

    So I guess my advice is, save what makes you feel safe and then pay off your debt as quickly as humanly possible. 🙂

  19. Back when we had debt, we were only getting paid 3x a year (grad student stipends). So putting all our money into debt was not going to work. I calculated how much it would cost to live plus a little cushion. Locked things into laddered cds (5% interest back in the day) that came due about when we’d be running out of money, and threw excess into DH’s student loans. Then lived on rice and beans (and potatoes and onions and free leftover grad food). Actually, I paid back my mom the $1K she’d loaned us for an apartment deposit first.

  20. I think I also over saved when it came to debt repayment, but I don’t really regret it. I had student loans after college, plus a car loan. Once I started learning about personal finance, I did calculations for saving interest by paying off the loans early. But then my husband and I saved up over 20k before paying off our 7k coar loan by writing a check. We also started paying double payments on my student loans, and once we had something like 35,000 saved up, paid off my remaining student loans.

    Really, we could have saved more in interest by paying off more each month or writing the pay-off checks sooner. However, we traded some interest saved for the security of cash. I need a large cash buffer to feel safe, so a large efund has always been a priority. We now have a 10 month efund, which I LOVE having.

  21. This is exactly what I suggest. First build up a cushion of around $500 in your checking account. Then put between 1 to 2 months of bare minimum living expenses (because you’d get rid of any non-essentials in a real emergency anyway) in a savings account. Then use every extra penny after that to pay off debt. Then build up that emergency fund to at least 6 months!

  22. We have a ton of money in savings- about $20,000 and also a ton of debt. we are saving to build our dream home, and we have a set amount to save every month and we have been. everything else goes to pay off our debt. Some people would look at us and say we are just sitting with TOO much money in savings, but every situation is different.

    When we first sold our house and started renting I thought it would be great to take most of our savings and pay off some of our debt to save on interest. But following our plan we won’t be paying THAT much more in interest by continuing to save and paying down our debt more slowly.
    Plus, AFTER 4 months of renting, I’m temped to put all our extra into our savings so we can build and move away from people again. Neighbors are terrible and I want a real house with real personal space that people don’t invade!

    Again- a different situation, but I think we will be building within 24 months and have everything but the morgage paid off in about 36 months. (I’m tempted to pick up a part time job just to be able to build our house faster!)
    Plus I like having the cash sitting around liquid, because neither of our jobs are too stable. Construction industry really slows down around now and through the winter, and my husband has no paid time off (no holiday pay, vacation or sick time), and layoffs are a threat where I work. Having the cash to live on if one of us becomes laid off is peace of mind right now!

  23. I am so glad to have found this post. I am in an unusual situation in that I own my home clear, own my truck clear, have 3 months of student loans left and have one debt after that which is my credit card. I don’t work however and live on a small income because my child care costs where I live are really high (no subsidies). I have had one time where the ex decided not to pay child support but he seems to be regular now. My interest on my credit card is in the single digits. I wonder too if I should have a larger emergency fund and just make minimum payments or if I should pay my one debt down as fast as I can? After reading the comments I think I should eliminate the debt and then work on the savings.

  24. Ninja, you might recognize me as the inspiration of this post. I’d like to give an update on a most recent event….

    My wallet was stolen along with $700 🙁

    Luckily my fledgling savings account/emergency fund was just enough to cover 1 months rent + utilities otherwise I’d be behind.

    I, now, definitely favor getting the emergency fund up to a good level ASAP then going nuclear on debt.

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