Which First: Save or Pay Off Debt?
The chicken or the egg paradox. It’s such a dilemma. How do you figure out the cause and effect? You can’t have a chicken without an egg first, so the egg must have come first. Right? But then you can’t have an egg without a chicken laying it…so did the chicken come first?
This is the exact pickle you find yourself in when it comes to a lack of savings and being in debt.
You can’t save money because you’re in debt. All the “extra” money you have goes towards debt payments. But if you weren’t in debt, all that money could go into your savings account. So obviously you should pay off debt first.
But one of the reasons you’re in debt is because you can’t save money! You have no savings, so when an emergency happens–flat tire, your kid chips their tooth, an unexpected trip to the ER–you have zero money to pay for those expenses. So with a wave and swipe of the “magic wand” called a credit card, you’ve got it made and paid. Except you don’t. Because you didn’t actually pay for it–you just added to your debt. And you certainly wouldn’t say “you’ve made it” because that usually implies success and happiness. I don’t know too many people who would use the words “success” and “happiness” to describe living in debt. So then saving money seems like the logical choice. If you have money saved, then you will have the money to pay for things and not go further into debt.
The problem is you don’t know which to tackle first: saving money or paying off debt.
Both are important parts of managing your money. Both are part of the equation. It’s like the chicken or the egg. Which comes first?
Saving money is the priority.
You’ve got to create a buffer between you and life so you have the ability to pay for unexpected emergencies as they arise–because they will. You cannot solve a problem (eliminating your debt) while simultaneously creating it (using debt to cover unexpected expenses).
Now hear me clearly: I am not saying you should prioritize a fully funded emergency fund before starting to tackle debt. Instead, save a starter emergency fund. The reason is twofold. First, a fully funded emergency fund is three to six months of expenses. Your monthly expenses are much higher when you’re in debt because of all those pesky debt payments. So the amount of money you would need to save is much higher. Secondly, you likely don’t have the margin to quickly save that amount of money if you’re in debt. If you’re just squeezing by, it’s going to take quite a while to save up a fully funded emergency fund.
Saving money is the priority, yes. But only save enough to give yourself a buffer so you can start pay off your debt.
So how do you do it?
Here’s how to balance saving and paying off debt:
First, save a starter emergency fund.
Before you do anything, you must put a hedge between you and life. Do this by saving $1,000 as your starter emergency fund. I hear a lot of push back against $1,000 because it’s “not enough money.” I agree. It’s not supposed to cover everything and all emergencies. A thousand dollars isn’t supposed to give you this warm and fuzzy sense of security.
Let’s take a look at some research. According to Bankrate’s Annual Emergency Fund Report, a staggering 40% of Americans surveyed said they would have to cover an unexpected $1,000 expense (like a car repair or emergency room visit) through financing the cost by using their credit card, borrowing from friends/family or taking out a personal loan. Sheesh! I bet $1,000 in savings would give this group some warm and fuzzies. On the other end of the spectrum, only 4 in 10 Americans surveyed said they could cover a $1,000 emergency expense with money from their savings. I’m going to go out on a limb here and infer that the majority of Americans do not have $1,000 in savings. Does that surprise you? Don’t balk at saving “just” $1,000. Having a starter emergency fund will provide margin between you and life so that you can tackle your debt.
Next, pay off all debt except your house.
Do this as quickly as possible–ideally two years or less. I’ll be honest, it took my husband and I longer than two years and it was a job. We had a lot of debt. From my own experience and helping those I coach, when it takes longer than two years, fatigue starts to set in. To combat this, you need to quicken your pace by lightning the load. Get on a budget, cut your expenses, sell some stuff (your stuff has stuff, amiright?!), work overtime and/or get a second job. The best method for paying off debt–and the one my husband and I used–is the debt snowball. Do this quickly.
Third, save for known upcoming expenses.
Inside your budget, you need to save for known, large upcoming expenses. You travel each Thanksgiving to visit family that lives in a different state. Figure out how much it’ll cost (gas, flights, car rental, food, hotel, etc), and then save for it. You know your car is going to need a new set of tires this summer. Figure out how much it’ll likely cost, and then save for it. Christmas comes every December. Decide how much you want to spend on presents and festivities, and then save for it. None of the above expenses are emergencies. None of the above expenses are surprises. They are known events. Some are even choices you make. Plan and save for these costs. Doing so–well in advance–gives you peace and control over each expense. It also prevents you from continuing to dig a hole (going deeper into debt) while you simultaneously attempt to fill it (pay off debt).
Saving money and paying off debt are both cornerstones of creating a solid financial foundation for your life. Save a little first, pay off your debt, save for upcoming known expenses and then once you’re debt free can you completely fund your emergency savings.
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