Aug 19 2008

Building up savings while getting out of debt


I’ve seen a few posts around the blogosphere about whether it’s good to pay off your debt first or build up savings.

At I Pick up Pennies, the author doesn’t want an emergency fund until she’s out of debt (I spotted a link to this post at Get Rich Slowly.). It might work for her, but it would scare the pants off of me. Being a primarily one-income household, our emergency fund will be used for insurance deductibles, emergency trips to places, and the big one: Loss of income. Shane and I have maybe a $13k credit limit or so on all of our cards. Yes, we could live off of our cards for six months if we had to. But do I want to do that? Oh heck no.

Sure, if you have a credit card with a high limit, you could probably charge an emergency. But if you’re already deep in debt, adding $1,000 will turn into a lot more by the time you’re able to pay it off.

Karen at Living Well on Less is taking a balanced approach. She’s putting half of her surplus funds toward debt, and the other half toward savings. She and her hubby see a real need to have cash on hand when they move in a few years, and it makes sense to beef up the savings for now.

There is no perfect answer for everyone. You’ll have to decide what works best for yourself, of course.

That said, if I had to give you my opinion (and I will. Cuz that’s what blogging is all about!), I would say that I’d suggest building up at least a small emergency fund before tackling debt could save you a lot of headaches.

Or, if you find yourself in a situation where you’ll need plenty of cash on hand, it makes the most sense to sock away as much as possible while just paying the minimum on your debt.

Popular financial guy Dave Ramsey suggests saving a $1,000 “baby” emergency fund before starting your debt snowball. Having $1,000 in savings will cover most people’s insurance deductibles, cover smallish home or car repairs, and cover you in many other emergency situations. If you’re committed to getting out of debt, then you need to be committed to avoid going further into debt. Having this small savings set aside can be just the ticket.

Having even a small emergency fund in place no matter what might give you a peace of mind. You’ll sleep better. And once you’ve seen you can squirrel away a thousand big ones, you might be motivated to save even more or carry on getting out of debt.

Detractors might say, “But you’ll net more money if you pay off debt first and avoid interest charges, and then put money into savings.” That might be true, especially if you’re fortunate enough to avoid any emergencies (and for the record, when you’re living paycheck to paycheck, ANYTHING can feel like an emergency).

But. To that, I would say, “If you’re so good with money, then you wouldn’t be in debt in the first place.” So there.

We’re within spitting distance of completing our emergency fund. We still have a car loan, and we’ll leave that alone for awhile. We want to have as much savings as we possibly can scrape together, since by now you all probably know we’re having a baby boy at the end of this year.(Yay!)

For now, it’s better for me to have more money in the bank than a paid-for car at this stage.

What’s your take on this?

Posted under Uncategorized | 18 Comments »

18 Responses to “Building up savings while getting out of debt”

  1. I completely agree. I might feel differently about it if I was closer to paying off my debt, but we’ve got a ways to go before our student loans are paid off. I don’t want to spend the next 5-10 years with no savings or emergency fund! Besides, when you’re deep in debt, it’s really reassuring to watch that savings balance climb AND watch your debt dwindle at the same time. It makes me feel more secure!

    Karen’s last blog post..Just say no to the birthday lunch

  2. We were like you, and wanted a solid emergency fund even with outstanding debt. We very quickly after getting married two years ago built up a 3-month emergency fund and left it there. At the beginning of this year, however, were were determined to pay off debt, and threw everything extra at our student loans. When the debt got so low that we could pay off the remaining balance with our emergency fund, we followed Dave Ramsey’s advice, left ourselves $1000, and got rid of our debt for good.

    So, now we’re left with a much-depleted emergency fund, but no debt, and room in our monthly budget to quickly build up a 6-month emergency fund- even higher than before.

    Saving vs paying off debt IS a hard question. Initially, we chose to save an emergency fund and a down payment for a house instead of paying off debt quickly. Was it the right decision? I don’t know. It’s all about priorities. Everyone’s going to have their own answer- sure, there’s a “mathematical” answer, but priorities trump math most of the time.

    Joanna’s last blog post..Technology is Awesome

  3. Right on! We have $1000 saved up… but it doesn’t feel like enough and are now trying to build up our emergency fund slowly while at the same time attacking our debt.

    JB’s last blog post..Posts Of Interest

  4. I’m a big fan of Dave Ramsey, and he points out over and over that getting out of debt is not just about numbers. That’s the problem with the get-out-of-debt systems that pay attention only to interest rates — or that advocate using 0% interest loans. It’s also about your own behavior and your own spirits. Paying off a debt lifts your spirits, so it makes sense to start with the smallest one regardless of interest rate. And having a small emergency fund is a huge relief that makes it easier to justify putting *all* your spare cash into debt repayment.

  5. We’ve saved up a $5k emergency fund (around 2 month’s worth of expenses), and we’re now splitting our extra cashflow evenly between debt and additional savings. The additional savings will be used for investments in new side business or tax liens to generate additional income to pay down debt. It feels good to see our assets growing while we’re paying down the debt. Otherwise it would just seem hopeless.

    We’ve even considered renting our house out for a few years and moving to my parent’s farm. That would really cut our living expenses and allow us to make real progress financially. Just gotta get that income so that it’s not tied to a physical location =)

  6. Just starting an emergency account is a huge step for many people. We have friends that don’t have any emergency or savings account and they feel the pain when they need to fix the car or get sick from work.
    It can be very overwhelming, but $1,000 is a great start. I think we should have at least 3-6 months in an emergency account as you never know what can happen if a spouse loses a job.
    Don’t worry about $1k or $100k, just start an emergency account.

  7. Well, first of all, thanks for the mention!

    And, as I state in the article, everyone *does* need to do what feels right to them. I absolutely agree.

    But I do take issue with the assertion that “If you’re so good with money, then you wouldn’t be in debt in the first place.”

    I’m on disability and finally (after two and a half years on disability and 18 months fighting to get on disability) working up to a part-time job. My disability check is $832 a month. Our rent just went up to $700 and it’s a one-bedroom. And right now we rely on use of my mom’s car, so moving to a cheaper place (which aren’t exactly abundant) isn’t much of an option.

    My husband has severe eczema that affects his ability to work. So even at the best of times, I’d say he missed at least two or so days a month of work. At the LEAST. Meanwhile, he came into the relationship with debt (student and a debt from an accident that kept his license suspended, which made it hard to get a job, which made it hard to pay off the debt, ad infinitum) and a severe calcium deficiency (inherited and exacerbated by all the steroids for eczema). His teeth had all broken off — in one case, on pasta. For the three months before we got him into an oral surgeon, he ate ice cream and yogurt. Oral surgery to remove the roots of 26 teeth? $7000. Dentures? $1500 for each (upper, lower). Dental coverage? 50% up to $2000.

    Then, after two years, his boss couldn’t put up with any more absences (he was averaging maybe 3 days a week, would get MRSA and miss a bunch of work until he was non-contagious, and then come back until another sore cropped up).

    So now he’s on unemployment and I’m on disability. I’m having him get rid of the MRSA (it loves hanging out on eczema skin and waits until it sees an opening, then dives back in) and get his skin under control. And also go to a vocational rehab program that will help him find an employer who will work around what is, at this point, basically a disability.

    In the meantime, with my new work (while I still earn disability checks and my part-time work for the first 9 months) we earn $38,000 a year.

    Still, just since late May, we’ve paid down his student loans from $2000 to $1230 — as of two days from now $1030. Once we’re done with that (hopefully in Sept/October), we’ll turn our full attention on the credit card debt.

    When you get sick, you’re pretty much at the social program’s mercy. If I hadn’t had a support system, I have no idea what I’d have done. And as it is, Medicare doesn’t cover a medicine that I need in order to be able to leave the house most days. It’s $400ish a month here; $100ish a month in Canada. Guess which I chose. Plus the hundreds (probably over a thousand, really) of dollars we spend on over-the-counter lotions and balms to keep my husband’s skin as moisturized as possible, since he itches every second he’s awake.

    So I bristle a tad under the insinuation that we’re somehow responsible for our debt. We certainly have splurged on occasion, because frugal burnout is ugly, and I take responsibility for those times. But most of our $12,000 debt — at least $10,000 — is earned honestly through just the bad luck of genetics and happenstance.

    And I do insist that if you pay down your debt as you go, you have a more clear credit line for emergencies. That said, sometimes psychology is more important than math. And if you don’t feel safe without an emergency fund, you’re not doing yourself any favors by listening to me. Because if you don’t feel safe, you’re more likely to make bad choices or overreact to emergencies.

    I was simply pointing out that in my case, it makes more sense. Because we may have paltry sums coming to us, but they’re regularly scheduled paltry sums. So we can plan around them.

    Not everyone is in this situation.

    I do hope people know that what’s most important about debt reduction (and part of the reason I wrote this article — and now this ridiculously long comment) is to think for yourself. Just because someone says emergency funds are important doesn’t mean they’re right for you. And just because I say they’re often mathematically a bad choice — and a bad choice for my situation — doesn’t mean that my plan is right for you.

    Abby’s last blog post..Martha Stewart of frugality? Not me

  8. We haven’t started our emergency fund, but we just switched to the Cash Envelope System/Dave Ramsey system in the last few weeks. My husband will be getting a $3K bonus in about 3 weeks and we already decided that $1K will be our “baby emergency fund”, $1K will be socked away for Christmas shopping and the other $1K will go towards our debt snowball. Luckily our total debt (aside from the house) is fairly small, and we should be out of debt with our next tax return (if not sooner).

    Mindi’s last blog post..Five Baby Steps to Being More Frugal

  9. Our $1000 emergency fund has worked for us for a year now. Just having it seems like insurance against needing it.

    Tenille’s last blog post..Well Hai

  10. I tend to agree with the Dave Ramsey way of doing things – building up a $1000 (or $2000 if you like) baby emergency fund, and then paying off debt. I has worked for so many others, there must be something to it!

    Pete’s last blog post..Money Matters

  11. Yikes. Big yikes, Abby. I’m really sorry you have to deal with all of that!

    Medical debt is one of those types of debts that can really sneak in and get you if you don’t have amazing health insurance or a large emergency fund already in play.

  12. Quote from your post:

    “But. To that, I would say, “If you’re so good with money, then you wouldn’t be in debt in the first place.” So there.”

    I had to bristle a little bit at this one, even though we have never carried credit card debt. We all have to realize that everyone is in different situations in life because of totally different reasons. There’s a big difference between $20,000 in credit card debt for Coach purses, $20,000 in student loan debt for a degree, and $20,000 in medical debt due to a bad hospitalization. Everyone has their own reasons for their strategy toward money.

    As for paying off a car, I would unless perhaps it were at 0% interest. Because of that same reason you quoted: loss of income. I can tell you from experience with lay-offs, when your income disappears it is wonderful to not have car payments, credit card payments, etc. hanging over your head. We’re stressing now because of health insurance costs, but don’t have to stress over monthly payments on debt (other than our mortgage). If you’re paying more in interest on your car than you’re earning at ING, you’re loosing money in interest as well with what you sock away versus paying down your car loan.

    Rachel’s last blog post..Yeah, I’m a cheap date!

  13. Yeah, a few of you didn’t like that statement of mine. I’m not slamming anyone–if I was better with money, I wouldn’t have a car loan right now. I’m not saying I’m perfect.

    We could have purchased a cheaper clunker car and have it paid for by now, but we didn’t.

    We owe about $9k on the car. We *could* use our emergency savings to pay that off, as it’s about 6.95% interest and we’re only earning 3% with ING.

    But as I said, we’re a one-income family and we’re having a baby in four months.

    We’re not going to risk wiping out our savings just to eliminate a $277 payment, even if that makes more financial sense.

    Right now, we need plenty of liquid cash. Our emergency fund will be enough to pay our car payment (and other expenses) for six months if we need to go that route, which I’m hoping we won’t.

    We’ll pay that car off later when we can do it without putting ourselves at risk.

  14. Oh, no, I didn’t mean using your EF that you already have to pay off the car. I meant since you’ve already established your EF w/6 months of expenses, I would go the route of paying extra on the car instead of sticking *everything* extra into the EF. With much more coming in than going out, I would pay off some of the higher interest debt in order to be losing less money and getting closer to getting rid of the debt.

    Rachel’s last blog post..Yeah, I’m a cheap date!

  15. I definitely think “to each their own”, you know? I wanted to build a small emergency fund ($1500) and then switch to debt reduction, which is what we’ve done. We have just enough in savings to cover a true emergency (hopefully) and once we get our debt paid down, we’ll get a larger emergency fund in place (6 months of income, hopefully). great article, though.

    tiffanie’s last blog post..a look at the 7 “debtly” sins

  16. I think Karen has it right. An emergency fund is a “must”, and paying down debt is a “must”. So, there’s really no other obvious choice for risk averse people other than doing a little with both.

    I suppose if your risk profile is lower, or if you have friends and family that you could lean on for an emergency fund, you could defer building up an emergency fund. Not many people have that luxury though.

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Hey! I'm Kacie, wife and mother of 3. I write about my family's finance: how we save money, improve our spending, and plan for the future.

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