Get Out of Debt First, Then Focus on Saving

by Debbie Dragon on 23 November 2009 18 comments

When you’re in debt, it’s nearly impossible to save money. To motivate yourself for the mission of getting out of debt, ask yourself these two questions:

  1. How much money am I paying towards my debt monthly?
  2. How else would I like to use my money?

The money you save while paying off debt is not likely to earn as much interest as the interest you pay towards your debt. It makes much more sense financially to commit to paying off high interest debts first, and then you'll have more money to save. Sometimes, it even makes sense to use your savings to pay off debt. Here are some tips for getting out of debt so you can save or invest the money you're currently using to make your debt repayments.

Designate your money with a budget.

This allows you control where your money gets spent rather than wondering where it all went. Stretch your budget dollars by using coupons alongside sales papers and use an allotted amount of cash rather than your debit or credit card. Also, use the Internet for numerous sites offering coupons and freebies.

Make your primary mission to become debt free.

While it saves you money to pay off debts with the highest interest rates first, sometimes it helps to pay off your debts from the smallest amount to largest. It gives you a sense of accomplishment faster. Remember though, each time you pay off a debt, that payment amount is now available to apply towards to the next debt to significantly reduce the time it will take to achieve financial freedom.

Consider transferring your high interest debt onto a 0% balance transfer credit card.

They are available for six months or twelve, introductory rate, and offer the opportunity to pay off principal debt rather than paying primarily on interest.

Get a new insurance quote.

You may very well be paying much more than necessary for your auto, home, and life insurance. You can easily compare insurance quotes online through sites like netQuote and esurance. Type in your info once and get multiple quotes, for each insurance type, and do comparison shopping from the comforts of home.

Dining out is not a priority.

Until you’re free from debt, dine out as seldom as possible. Plan your meals in advance and build your grocery list according to your week’s menu. This will save you money on your grocery bill and on eating out too frequently. Let your slow cooker/crock pot work for you. This includes breakfast and lunch; make your own coffee and pack your lunches (yours, the kids’, and dad’s too). Dinner leftovers can be used for another meal or lunches.

Once you designate where your money is being spent and strive for financial freedom, then you’re able to consider saving for short term (Christmas club) and long term funds (College & Retirement). The sooner you pay off high interest debts, the sooner you can begin saving and benefiting from the interest your savings earn.

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Guest's picture

You've touched upon a great concept, motivation. Without it no one will change. By asking yourself those questions you just my find the reason you are going to change.

I also love the advice to get insurance quotes. I see people all the time save hundreds of dollars in a matter of minutes just by reviewing their insurance. I wrote a blog post called "6 Reasons To Buy Insurance Online" http://evolutionofwealth.com/2009/11/03/6-reasons-to-buy-your-insurance-...

What do you think?

Guest's picture

these are very good pointers but i think that you should have included more points on how to avoid overspending cash, like the eating out bit. Personally i think that those people that are not responsible enough with their cash and credit cards should cut them up because that plastic gives the naive that feeling of being rich and that you have the ability to buy whatever you want. I mean lets be real, isn't it the reason that most are bogged down in debt??

Guest's picture
Diasdiem

The problem with aggressively paying off your debt is that you can cut out so much enjoyment out of life. I'm not as debt-heavy as a lot of people, just a very manageable car payment. I could spend every cent not going to food and shelter on the car payment, but I'd be miserable the whole time. Going by the amortization table, paying it off as aggressively as possible will only save me a few hundred dollars over the course of the loan, and that's not worth it to me to not go out ever or buy myself something nice once in a while.

And if you don't have some money in savings, and some financial emergency comes up where you could use those savings to pay for it, you just go deeper into debt.

Guest's picture
Beth

I find many articles (like this one) use the general terms "savings" and "debts" without making distinctions. There's a big difference between a high interest debt (like a credit card) and a lower interest debt (like a student loan). Likewise, saving for retirement or an emergency fund is different than saving for "wants" like a home, car or vacation.

I'm not letting my student loan stop me from saving money for retirement. (Mind you, I've making a lot of sacrifices to pay down extra on the loan and make my retirement goals). I can't afford to lose the years for compounding, and I get money back at tax time (which is much higher than the interest I would have paid on that money throughout the year).

This article makes some good points, but there's no right solution for everyone.

Philip Brewer's picture

@Beth:

Good point.  My take is that it's reasonable to deal differently with debts that are at low, fixed rates, such as some student loans and mortgages.  In that case, it may be reasonable to treat the debt as if it were an expense, and simply plan on paying it off over time, rather than moving more aggressively to get paid off early.

Still, it's worth comparing the rates (adjusted, if necessary, for the tax advantage of mortgage interest).  

In particular, don't be fooled by the notion that you're coming out ahead by saving "for retirement" if the rate that you're paying on your debt is higher than the rate you're earning on your savings.  It's true that you'll eventually get out of debt, and may have more money in your retirement account if you do that, but neither of those factors means much when viewed in isolation.  Your entire portfolio supports all your goals.  If, when you finally get your old loans paid off, your total wealth is smaller (because you paid more interest on your old loans than you earned on your savings), you're still coming out behind where you would have been--even if your retirement account is larger.  The "years of compounding" apply to everything--not just your retirement savings, but also your non-retirement savings and your debts.

Of course, tax laws make it complex to find the best path--there's the tax advantages of mortgage interest, plus the tax advantages of putting money into retirement savings. (Not to mention a corporate match on your 401(k) contributions, if your employer still does that.)  

I wrote a post on picking your way through those issues called when NOT to put money in your 401(k).

Guest's picture

While I completely agree with the necessity of getting out of debt, in any way that's most comfortable, I disagree with putting paying off debt ahead of savings for the reasons outlined in Start and Grow Your Nest Egg Even If You're Broke

Sorry about the self promotion here, but there's more there than I can say here.

Guest's picture
Anthony

The argument of whether to pay down debt... or to save a little, then pay down debt... or to save and pay down debt at the same time... is an overly argued one. It's all about personal preferences. Some people are comfortable with no emergency savings (while paying debt). Some people can manage without one. Some people aggressively pay down debt, while others take a slower method.

That's why it's "personal" finance.

Guest's picture
Jack

It's amazing how much you can spend on dining out without even realizing it. Those 15$ stops through the drive thru add up quick.

Guest's picture

Your advice sounds like that given by Elizabeth Warren (and her daughter Amelia Warren Tyagi) in their excellent personal finance book, All Your Worth.

Here's what they say about paying off debt, from the chapter, "To Build Your Future, Pay Off Your Past,"

"Paying for yesterday is perhaps the most important investment you can make in your future. Getting rid of those debts will buy you breathing room."...

Also, in the same chapter, "Debt is nothing more than yesterday's spending taken from tomorrow's income. It is a claim against your future."

Wow.

Sierra Black's picture

I needed this today.

I'm at that mid-point in getting out of debt where I haven't spent money on "fun" in a year and have nothing to show for it but smaller balances on my bills. Our belts are just as tight as they were when we started and it's NO FUN.

 

Sierra Black - embracing the wild heart of parenting at www.childwild.com

Guest's picture
andyg8180

I believe your nest-egg is your number on priority. YOU should be the most important bill in your stack of bills... Remember, CASH BEATS CREDIT anyday...

so lets say you pay off all your debt today, and you lose your job next week... or lets say your car breaks down and you need a downpayment for a new beater... OORRRR you get dings with an appendectomy...

You need that emergency fund now, and not later... Id rather take the extra year to pay down my debt vs not having any kind of savings...

Guest's picture

andyg8180--that's the point I made in my post link in comment #5.

In order to get out of debt, you first need to replace the credit addiction with something else, and the best alternative is cash.

Once you learn to live on cash, you won't need credit anymore. Until you make that transition, paying off debt is an uphill fight. With a cash cushion, you'll be halfway up the hill before you start the treck.

Guest's picture
Sandor

I think there are two sides to debt repayment, pay it down and don't get more of it, and would like to outline the strategy I've built based on that.

My wife and I have an emergency fund that doesn't get touched unless we have an unexpected _necessary_ expense (i.e. appliance repair, physio, prescriptions); a good deal on a TV or couch is not a necessary expense. If something causes the balance in the emergency fund to drop bringing it back up becomes the number one priority for the next month. I think an emergency fund is essential because the money for unexpected expenses only comes from one of two places: your savings or your debt. By having a buffer between yourself and everything else you minimize the risk of an emergency forcing you further into debt.

As for debt repayment, I've found the best way is to set up an automatic transfer on the same day you get paid and to put any found money (raises, bonuses, spare change, money saved from lowering a bill) directly onto debt to prevent lifestyle creep. Just make sure you have enough in your emergency fund.

Guest's picture
Guest

I just finished paying off $16000 in credit debt. We did first make sure we had a $2000 balance in our account at all times to make sure could pay for all bills at any time. But we transferred some balances around then start paying off the high interest ones first. We now just paid off the high interest 12.5% time share of $4k. Since all is left is asset backed loans, we need to build more savings until really start paying off the boat at 8.5%

Guest's picture
Guest

I completely agree with all of the comments emphasizing that we should have an emergency fund before throwing every penny earned towards paying off debt. I remember thinking a few years back that I didn't need an emergency fund because if I needed the money, I could just borrow back from the same credit card I just paid off. Today, with so many credit card companies cutting the credit limits, emergency fund is a MUST.

Also, I have a comment about the "Consider transferring your high interest debt onto a 0% balance transfer credit card" point. This could be a great idea, but don't forget that so many credit cards charge a balance transfer fee, which might make this move a more expensive way to get rid of debt than just simply paying on an existing card. Also, keep in mind that the balance transfer fee usually gets added to your balance as soon as the transfer is completed, which may also make the transfer more expensive. For example, if I have a credit card on which I am paying 4.5% and am planning to pay off the balance in six months, transferring the balance to a 0% credit card that charges a 3% fee would actually be more expensive.

Guest's picture

Dept consolidation is the answer. Check out: http://help-to-get-out-of-dept.allinterweb.com/

Guest's picture
Accurise

Emergency Cash: stash your excess piles of cash into a savings account with Schwab. Their “High Yield Investor Savings” account offers 2.00% interest rates. Even better? There’s no minimum and the account is insured by FDIC. You are also reimbursed for ATM fees.

Guest's picture

Finding that right balance between saving and paying off debt is tough. The numbers say to pay off the debt and press pause on the savings, but then what about the non tangibles (e.g. peace of mind)? How do you add that into the equation? How much do you save first before you tackle the debt?
So many questions to ask and it seems like every individual has a different answer (of course!). I've always thought it was good to save a month of expenses and then take on your debt full force. I like your suggestions of budgeting and dining out. It seems these are areas people fail the most when it comes to their money.

Thanks for sharing !