paying off http://www.wisebread.com/taxonomy/term/2027/all en-US When to Use Savings to Pay Off Debt http://www.wisebread.com/when-to-use-savings-to-pay-off-debt <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/when-to-use-savings-to-pay-off-debt" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/ambulance_0.jpg" alt="Emergency vehicle" title="Emergency Vehicle" class="imagecache imagecache-250w" width="250" height="190" /></a> </div> </div> </div> <p>One of the most common questions over on the <a href="http://www.wisebread.com/forums/">Wise Bread forums</a> is some variation on, &quot;I have $X in savings but $Y in credit card debt. Should I use the savings to pay down the debt?&quot; The answer, of course, depends on your situation--and there's a reason why the question keeps showing up. Here's how to do the analysis.</p> <p>The first step toward answering this question is to ask another: <strong>do you have an emergency fund?</strong></p> <p>That's because figuring out the <em>cheapest</em> thing to do is easy--just compare interest rates. If your savings are earning you less than the cost of your debt, then you'll save money by paying off the debt. But that's only the right choice if you have an adequate emergency fund.</p> <p>Of course &quot;adequate&quot; is a tricky question for emergency funds. I've written a whole article on <a href="http://www.wisebread.com/figuring-the-size-of-your-emergency-fund">figuring the size of your emergency fund</a> that breaks down the reasoning behind the rule of thumb that you want at least 3 and preferably 6 months spending in your emergency fund.</p> <p>For people with debt, though, the calculation changes. You still need at least a minimal emergency fund, simply to manage little glitches in cash flow (such as a payroll or banking hiccup that delays your direct deposit over a holiday weekend). But once you go beyond that minimum--maybe $1000, maybe one month's take-home pay--any extra emergency fund cash is probably costing you bunches in interest on your debt while earning almost nothing.</p> <p>A lot of people seem to think that having extra debt means they need to have extra in their emergency fund--so that they have cash to cover their debt payments during a period of unemployment. Sadly, I can't say that's definitely wrong: If you can't cover your minimum payments and start racking up late fees, those charges will totally swamp any interest payment savings.</p> <p>The analysis has to come down to your best guess on what the future might look like. My take is that getting the debt paid off sooner rather than later improves your situation so much that it's worth taking a small risk. After all, even a large emergency fund will go pretty quickly if it has to cover large debt service payments.</p> <p>So, my general advice is:</p> <ol> <li>Establish a small emergency fund--something like $1000 or 1 month's pay--to cover the ordinary cash-flow mismatches that always show up between income and outgo.</li> <li>Once that's done, aggressively pay down any debt (with the possible exception of long-term debt where the interest rate is both <em>low</em> and <em>fixed</em>, such as some mortgage and student loans).</li> <li>Once you're debt-free, bring your emergency fund up to the 3 to 6 months standard.</li> <li>Once you've got a healthy emergency fund, direct future money to investments. (Don't neglect <a href="http://www.wisebread.com/non-financial-investments">non-financial investments</a>, which will often return more than financial investments.)</li> </ol> <p>As I&nbsp;said, there's a reason the question shows up over and over again:&nbsp; There's no way to know the right answer. The more aggressively you pay down your debt, the cheaper it will be--unless you run your cash down so low that an interruption in your income means that you're unable to cover your debt service expenses. Since you can't know the future, any choice that you make will have to be based on your best sense of what the future may bring.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/when-to-use-savings-to-pay-off-debt">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/10-ways-to-prevent-an-emergency-from-driving-you-into-debt">10 Ways to Prevent an Emergency From Driving You Into Debt</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/11-ways-life-is-amazing-with-an-emergency-fund">11 Ways Life Is Amazing With an Emergency Fund</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/managing-your-short-term-money">Managing Your Short-Term Money</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-7-best-credit-card-debt-elimination-strategies">The 7 Best Credit Card Debt Elimination Strategies</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-inspiring-people-who-each-paid-off-over-100000-in-debt">5 Inspiring People Who Each Paid Off Over $100,000 in Debt</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance Debt Management debt emergency emergency fund How-To Guide paying off reducing debt savings Fri, 10 Jul 2009 12:00:02 +0000 Philip Brewer 3368 at http://www.wisebread.com Debt repayment is not an expense http://www.wisebread.com/debt-repayment-is-not-an-expense <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/debt-repayment-is-not-an-expense" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/credit-cards.jpg" alt="Credit cards" title="Credit cards" class="imagecache imagecache-250w" width="250" height="178" /></a> </div> </div> </div> <p>Over and over again, in budgeting articles and even books on personal finance, I see sample budgets that include debt repayment as if it were an expense. This shows a fundamental misunderstanding of what debt is. Your <strong>debt repayment is not an expense, it's an internal transfer</strong>. The only part that's an expense is the interest. The rest of the money was spent some time in the past, when you incurred the debt.</p> <p>The same principle applies when you put money into your savings account. That's not &quot;saving.&quot; The <strong>saving occured when you spent less than you earned</strong>. Putting the money into the savings account is, again, just an internal transfer.</p> <p>Suppose you owe $1000 on your credit card and you have $300 in your checking account and no other savings. Your net worth is $-700. After you write a $100 check and send it to the credit card company you've got $900 in debt and $200 in your checking account. Your net worth is still $-700. The result would be the same if you opened a savings account with $100 from your checking account: Your net worth is still $-700.</p> <p>This is important for two reasons:</p> <p>First, <em>you should track the interest part of the payment as a current expense.</em> Knowing how much of your monthly income is going to interest payments gives you important information about where your money is going.</p> <p>Second, <em>it's worth thinking what the rest of the money was spent for.</em> Today's debt payments are paying for stuff you bought in the past--maybe things you're still using, maybe things (like restaurant meals) that were used up before you even put the credit card back in your wallet. That's where your money went, not to some amorphous blob called debt repayment.</p> <p>It's true that, whether it's an expense or not, you do have to come up with cash to make your credit card payments. My pointing out that (as far as your personal balance sheet goes) it's really an internal transfer, cuts no ice with the credit card companies. They'll be delighted to tack on late charges if you don't pay. So you need to have room in your budget to shift actual cash from your checking account to the credit card company. Remember, though, that (except for the interest) it's not an expense.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/debt-repayment-is-not-an-expense">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-4"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/snowballs-or-avalanches-which-debt-reduction-strategy-is-best-for-you">Snowballs or Avalanches: Which Debt Reduction Strategy Is Best for You?</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-most-valuable-thing-debt-takes-from-you-isnt-money-its-this">The Most Valuable Thing Debt Takes From You Isn&#039;t Money — It&#039;s This</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-fastest-method-to-eliminate-credit-card-debt">The Fastest Method to Eliminate Credit Card Debt</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/when-to-use-savings-to-pay-off-debt">When to Use Savings to Pay Off Debt</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-get-back-on-track-when-youre-behind-on-your-bills">How to Get Back on Track When You&#039;re Behind on Your Bills</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Budgeting Debt Management budget budgeting debt debt reduction paying off Tue, 21 Aug 2007 21:51:50 +0000 Philip Brewer 1031 at http://www.wisebread.com