Do you need to save money when ditching debts?
Simple mathematics suggests that we should pay off debt before saving money. In general, paying off debt is a long battle. For instance, it takes 10-25 years to pay off student loans. Should you focus all of your energy only on paying off debt for so many years, or should you save money and pay off debt simultaneously?
The simple answer is – it depends.
Why you should save money and pay off debt simultaneously
The reasons are simple and clear.
First, you need money to pay off your debts fast. If you opt for debt settlement, you have to save money before the negotiation process starts. If you opt for debt management, then you need to save money for making the monthly payments.
Secondly, you need to set aside money for building an emergency fund. An emergency fund is a must when you’re in debt since it can help you cover unforeseen expenses. You can’t depend on credit cards anymore since that will only increase your debt problems.
Your mini emergency fund should be between $1000 and $2000. This would help you cover your short-term emergency expenses.
Examples of short-term emergency expenses
- Car repair
- Special days like birthdays and anniversaries
Set a goal to create an emergency fund that is enough to cover your living expenses for 3-6 months.
Fresh debts are a menace when you’re already in a financial crisis. When you have money in your savings account, you can easily cover your immediate expenses, avoid high-interest payday loans, and credit card debts.
Do you want to pay off debts as soon as possible? If so, then you have to make additional payments on your debts. And, it’s only possible to make those extra payments when you have savings. In debt avalanche method, you need to make extra payments on the high-interest debt. Likewise in debt snowball method, you need to make additional payments on the smallest debt till it is paid off. It will be tough to make those extra payments without saving money.
Lead a frugal life when you’re in debt since this will help you save money gradually. Cut off cable, cook at home, move to a smaller apartment, get rid of your second car, use CFL bulbs, host potluck parties, buy in bulk, avoid late fees, insulate your walls, adopt a minimalist wardrobe, borrow books from a library, stay healthy, find free entertainment, sell your unnecessary goods, drink water, travel frugally, save gas, sun-dry clothes, and quit smoking.
Retirement planning and debt repayments – both are equally important. So you need to save money to build your nest-egg too. Save money and contribute more toward tax-advantaged retirement savings accounts like 401(k), IRA and Roth IRA. You shouldn’t ruin your financial future just to pay off your debts. Try to increase your contribution rate by 1% every year since this will increase your retirement savings considerably.
How to save more and pay off debt fast
Have you saved an adequate amount already? If so, then you can invest to earn a higher return on your money. Consult a financial adviser and invest wisely since one wrong financial move can ruin you.
The stock market can earn you 4%-5% return on your investment after deducting taxes and fees. Calculate the interest-rate you’re paying on your debts. If it is less than 4%, then focus on investments over debt payoff. For example, auto loans and home loans. These are low-interest loans.
When you should give 100% focus on repaying debts
Forget about saving money when you have high-interest and non-tax deductible debts. Pay off your debts as quickly as possible to save on interest.
What if the interest-rate on your debt is between 5% and 7%? In this case, you can invest your savings and pay off debts simultaneously.
It is better to get rid of payday loans and credit card debts fast since these are high-interest debts. Some lenders charge 600% interest-rate on payday loans and push borrowers toward a deep ‘debt pool’. Try to get rid of payday loans quickly. Check out your state payday loan laws. Find out if payday loans are legal in your state. If your lender doesn’t have a license, then pay only the principal amount. Join debt forums to know about the strategies to pay off debt.
The final verdict
The final verdict is loud and clear. You have to watch out for the ways to save money while you’re paying off debts. You have to save money for buying a home, giving good education to your kids, building your nest-egg, and so on.
Try to strike a balance between saving money, investing and paying off debts. For instance, if you have transferred your outstanding balance to a 0% interest card for a short period of time, then it’s a golden opportunity to invest and pay off debt. Make sure you earn an amount that will help you pay off the debt before the new interest-rate kicks in.
You can pay off your low-interest debts fast and increase your contributions toward retirement savings plans. Once you pay off your low-interest debts, you can pay down your high-interest debts. You can use other strategies as well. It’s your choice. As long as you’re progressing financially, it’s fine.
What do you feel? Do you feel that it’s a horrible idea to save money while you’re paying off debts? What’s your opinion? Think and let us know.