Saturday, June 03, 2006

Pay Down Debt or Save Money?

"Should I use all my savings to pay down my debts?"

Financial advisor-types must get this question all the time. The following article isn't the first time I've seen it addressed at, either: "Credit Card Debt vs. Emergency Fund"

I am of the opinion that there isn't a clear-cut answer. What interest rates are you paying on your debts? What interest rates are your savings earning? How big a benefit would it be to you, psychologically, if your savings allowed some of your debts to disappear entirely? How big a detriment would it be to you, psychologically, if your "security blanket" of savings was absorbed into your debts?

All these issues come into play here.

Personally, as a "Good in Most Cases" approach, I like Dave Ramsey's "Baby Steps" advice: If you have savings, use all but $1,000 of it to pay down your debts. Later, if an emergency comes along, you have the $1k to help you out.

On the other hand, I've heard Suze Orman tell callers and readers to clean out their savings and throw all the proceeds at their debts. If an emergency happens after that (which it will), you'll at least have your credit cards (with their balances now decreased) to catch the slack.

If you're paying double-digit interest on your debt (unsecured debt, most likely, as in credit cards) then it makes zero financial sense to have much savings stashed elsewhere. That's the Financially Wise and Mathematically Correct answer, of course. But if your credit is exemplary and your debt's interest rates are low — say, 2.99% or less — thanks to promo offers or balance-transfer deals, then debt paydown becomes much more of a case-by-case issue. You might be able to earn more (after taxes, even) by keeping your savings.

But what Dave Ramsey addresses moderately, and Suze Orman merely touches upon, and David Bach brushes aside entirely, is the "fighting the symptom, not the disease" aspect of all this. If you have credit card debt, you're spending (or have spent at some time) more than you make. That overspending is the disease. Debt is just the symptom of overspending.

If you want to win at this game, you have to attack the disease as well as the symptom. I like the fact that Steve Bucci, in the Bankrate article above, focuses on this:

Using your savings now to pay off your debt is not something I would recommend. You are clearly spending more than you are earning, and I am concerned that if you bled your savings to pay your debts, you'd be so impressed with your new low balance that you would spend back up to the $18,000 limit or beyond.

Yes, yes, yes. If you didn't have the tools, or the desire, or the discipline, or whatever, to keep your debt from ballooning to X thousand dollars before, once it's paid down, what's to keep your debt from inflating right back up again? Your good intentions? Your local Congressman? Your Fairy Godmother?

If you're going to beat debt, there is one maxim which will apply to everyone: For just a moment, forget about whether or not to plunder your savings. Instead, worry first about yourself. Because your behaviors must change before your financial position truly can.

This is why I'm such a believer in (1) tracking your spending (Quicken, MS Money, et. al.), so that you know where your money is going, and (2) spending plans, so that you can tell your money what you want it to do. These things are about behavior modification. When you get right down to it, throwing money from "savings" at your debts is not.

So if you're one of those folks with $5,000 in savings and $12,000 in credit card debt, and you want to know what you should do with your savings ... well, in my opinion, you're skipping a much more important step.

Develop a plan to conquer your overspending first.

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— Posted by Michael @ 4:00 PM


Very, very well put. Thanks for the insight Michael!


In any case you generate more money then the deal is good.A person with money makes succesful plans and execute the way he wants.Middle Class have no choice.They earn to spend and most of their plans do not materialise.It is on this ,the credit card company cash on and make their recovery department very strong.Sooner is one out of credit card debt better it is for him.Of course if he is able to pay immediately the full demand on demand then it is good as well which happens in below 25% cases.That is the reason Credit Card is the most profitable business now.

** Comments Closed on this Post **

Thoughts on my personal finances, goals, experiences, motivations, and accomplishments (or lack thereof).

My financial life began turning around when I took responsibility for it.
— Dave Ramsey


Start (2005-12): ~$21,900
Currently: $0
[About Our Debt Paydown]


Savings Goal: $15,000
Currently: ~$15,115
[About Our Liquid Savings Goal]