Saving vs. Paying Down Debt

[Aristippus]

New member, joined just to ask this question. Please be kind; I'm honestly confused.

After years of living overseas, we recently returned to the U.S. and bought a home; this process gutted our savings and left us about 15k in debt (beyong the mortgage, of course) due to the need to rehab the kitchen. We've since aquired another $7k in debt, most of it because of a medical emergency (hospital payments + need to take leave without pay). We find ourselves now with a couple of questions about how to handle our finances, and are looking to the wisdom of crowds.

QUESTION 1 - Given the following, should we be building up an emergency fund or paying down debt?:

a) $20k in debt, at an average of 7%
b) About $3k total in savings -- no emergency fund at all
c) About $750/month available for either debt payment or savings
d) An expected windfall of about $5k coming soon

QUESTION 2: We also have about $250k saved for retirement (we're in our late 40s, and I will also have a pension upon retiring). Right now we're contributing 15-16% of our pre-tax income to our retirement accounts. Is it worth dialing that back in order to deal with debt and build up other savings?

Thanks in advance for any insights!

[Joan.of.the.Arch]

If your pension is enough to live on in retirement, then yes, I'd suspend at least partial payments to your other retirement savings while you work on other debt and also further emergency savings. However, if there are cutbacks you could make in day to day living in order to pay down debt, I'd do that to speed up the process.

Sorry about the medical problems and hope that is all behind you. At any rate, it shows you a real reason to pass on some of the "wants" in order to save for needs. Medical debt plus lack of pay while ill underscores a need that you might have to provide for again in the future. A clear reason to have some emergency savings.

The kitchen remodel is already done, but that might be the sort of thing that, going forward, you should put off until you can save up for it. Or even if you choose to finance an expense like that, it would be better if you first put into place a plump emergency savings. You don't want to be backed into using whatever credit is available in an emergency (usually credit cards.)

As for that $5000, I think I would split it and put some into savings, and send some immediately to debt.

[snshijuptr]

I would pay off the individual debts from highest to lowest interest. Since you already have $3000 in savings, I would direct all future money toward debt payment. I would suspend retirement until all 6% or higher debts are paid off then resume retirement. With all $5000 going to debt and only the $750 a month, you can pay it all off within 2 years. With the retirement, you can probably shave 6 months to a year off of your debt repayment.

I'm thinking that if you put in a little extra effort, you can pay off your debts and have around $10K in savings in about 2-2.5 years.

[Scanner]

I'll part ways with the forum. I'd either

A. Split in half - go with paying down debt half and saving half.

or

B. Build up savings with the entire 750/month.

It's a concept called leverage.

WIth only 3K in savings you have no leverage. Yeah, you have an income but that's your only leverage.

YOu need to work on raising the ASSET part of your net worth vs. reducing the LIABILITY column.

[Aristippus]

Originally Posted by snshijuptr

I would pay off the individual debts from highest to lowest interest. Since you already have $3000 in savings, I would direct all future money toward debt payment. I would suspend retirement until all 6% or higher debts are paid off then resume retirement. With all $5000 going to debt and only the $750 a month, you can pay it all off within 2 years. With the retirement, you can probably shave 6 months to a year off of your debt repayment.

I'm thinking that if you put in a little extra effort, you can pay off your debts and have around $10K in savings in about 2-2.5 years.

Thanks! (And to Joan, too). I forgot to say in my original post that dialing retirement down to zero isn't a good idea, because of employer matching funds (employer throws in $1 for every $2 we contribute, up to 5% of each of our incomes), but we could still dial it back to 10% and get the full match; that would probably free up another $300-400/month for debt payments, after taxes. But since my retirement fund is pre-tax, I'd be giving up $700-800/month in retirement funds in order to put $300-400 toward debt. I think debt is to be avoided, but that seems like an awfully steep price to pay in the long run. Am I not thinking about this correctly?

[bjl584]

Originally Posted by Scanner

I'll part ways with the forum. I'd either

A. Split in half - go with paying down debt half and saving half.

or

B. Build up savings with the entire 750/month.

It's a concept called leverage.

WIth only 3K in savings you have no leverage. Yeah, you have an income but that's your only leverage.

YOu need to work on raising the ASSET part of your net worth vs. reducing the LIABILITY column.

I'll second this. Without cash on hand you will be forced to finance just about everything that you need to buy. You need to build up your cash reserves.

[Hector]

I would stop contributing to retirement account if I have 20k debt at 7%.

In 40s, I would like to have 6-8 months of EF.

I would use 5k + 750/month + money because of stop funding retirement/month to fund EF and pay off debt before start contributing to retirement accounts.

Later on this thread, I read that you are getting employer match. In this situation I would keep contributing to retirement till the point of match.

Originally Posted by Aristippus

But since my retirement fund is pre-tax, I'd be giving up $700-800/month in retirement funds in order to put $300-400 toward debt. I think debt is to be avoided, but that seems like an awfully steep price to pay in the long run. Am I not thinking about this correctly?

Don’t worry too much about it. Though you are savings tax now, you will have to pay tax later on when you withdraw.
Though you are investing 700-800/month, you are gong to get less than that when you start withdrawing because you will pay tax on it eventually.

[couchrobt]

Who would not dream of being debt-free soon. Of course it is every body's wish. But the wait and patience just have to be there.. at all times.. 24/7.

[KiwiJo09]

Originally Posted by Scanner

A. Split in half - go with paying down debt half and saving half.

That's what I do. I save half and use the other half to pay off debt.

[Hector]

Originally Posted by couchrobt

Who would not dream of being debt-free soon. Of course it is every body's wish. But the wait and patience just have to be there.. at all times.. 24/7.

It would be nice if everybody thinks about not taking any debt in the first place. I am sure that there wold be circumstances that it cant be avoided, but I dont think its the case a lot of time.

[jpg7n16]

1) If any of the debt is on a credit line, like a credit card, then I'd put all the free cash to paying down credit cards with high interest rates.

This will reduce your debt, reduce interest costs, but leave credit available for borrowing in the event of an emergency. Not ideal, but better than not having credit.

So I'd put it all towards credit card debt each month.


But if it's not on a credit line (like car debt, which you can't re-borrow) then I would do the 1/2 and 1/2 as described above.


2) In your situation, here's how I look at it:

It's ideal to be strong financially in the three areas you are conerned about - debt level, available cash, and retirement savings. And if I were to evaluate your situation, here's how it looks to me:

Debt level - weak
Cash liquidity - weak
Retirement savings - strong

So I would say that you are in a decent position to temporarily sacrifice retirement savings in order to strengthen your debt level and cash liquidity.

Therefore, I would likely reduce my retirement savings to just the company match and shore up those two areas. Then switch the retirement savings back on.

[guidemesingapore]

The benefit that I like the most for paying down debt with investment income is that when your debts are paid off, you'll still have all the investment income paying you every month or quarter. And as I have said before, investment income is the ultimate financial goal of personal finance - managing your money until it can pay all of your expenses through investment income. So begin with the end-goal of investment income immediately and two-step your way out of all of your debts.

[Aristippus]

Just wanted to thank everyone for their advice; meant to do that sooner, but it's been a busy few weeks. Looks liek we're going to (1) reduce our retirement contributions from 15% to 10%, (2) go the half-and-half route. With any luck, we'll have ourselves sorted (out of debt, emergency fund fully funded) in about 3 years.

Anyway, thanks again! This seems like a very nice online community!

[jerrycates]

If you can do a balance stuff on these two, that will be better. That's just me however. If you believe that getting rid of debts first is a better move, then by all means. do it.

[Frugal]

I personally am trying to focus on building up an emergency fund, and although I don't agree with Mr. Dave Ramsey on everything, I think he is right on this one. Like you, I too have debt, and am in the process of needing to and trying to build up an emergency fund. Once I do that, THEN I will focus exclusively on building up debt.

[KennySoward]

I'll step away from most of the posters and say to just put a majority (75%-85%) of it into your debt. Based on the $750 per month you have available, you can get the job done in maybe two years, and still grow the emergency fund a little. In my experience, paying off a lot of CC debt (20k isn't too bad, but nothing to laugh about) just a little at a time never really gets the job done in a decent amount of time.

Not having an emergency fund is playing with disaster a little, but I'd shoot for lowering your high interest before that. If an emergency does come up, then you have some money to play with on your CC anyway because you have been paying it off.

Sounds like you made a decision already, so good luck. I think it would have been my next choice.

[sylviaB]

You can make your choices. I suggest, A. Split in half - go with paying down debt half and saving half; or B. Build up savings with the entire 750/month. There's no much problem since in the best of times, a certificate of deposit is a low-risk investment that gives reasonable compensation. But when CD rates are as low as they are today, consumers are well-advised to look elsewhere, suggests Bankrate.

[sylviaB]

its a matter of discipline and determination to budget the money you have save and pay off your debts.

[timib]

Pay off the debt, keep some in cash. best way to make it

[Aristippus]

Originally Posted by KennySoward

I'll step away from most of the posters and say to just put a majority (75%-85%) of it into your debt. Based on the $750 per month you have available, you can get the job done in maybe two years, and still grow the emergency fund a little. In my experience, paying off a lot of CC debt (20k isn't too bad, but nothing to laugh about) just a little at a time never really gets the job done in a decent amount of time.

Not having an emergency fund is playing with disaster a little, but I'd shoot for lowering your high interest before that. If an emergency does come up, then you have some money to play with on your CC anyway because you have been paying it off.

Sounds like you made a decision already, so good luck. I think it would have been my next choice.

Thanks! One thing informing the choice is that the debt is all pretty low-interest -- all but about $1000 of it is under 6.5%, and that last $1000 is still under 8% -- so I feel a little more comfortable with a 50/50 split. If the interest rates were higher, I'd probably be focusing exclusively on debt. Plus, while I think we're out of the woods medically, this winter certainly taught me the hard way about why an emergency fund is a good thing.