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I'm trying to figure out how to balance paying off debt, and saving for the future. Does it even make logical sense to do both at once? More specifically, does this prioritization of short-term financial goals make sense:
1. Build up emergency fund to 6 months expenses
2. Increase payments on debt to retire it faster (relatively faster)
3. Increase deposits into long-term savings accounts
I'm particularly unsure about the order of 2. and 3.
The household is 2 adults and one baby, with one base salary of $51000, plus more income that fluctuates year to year. Last year overall household gross income was $56000. Next year the total household gross income will be about $75000.
Our first goal, still working towards it, is to get 6 months of expenses in the bank savings account for emergencies. Focusing on doing that first, before trying to attack goals 2 and 3.
DEBT:
I am well aware of the foolishness of going into too much debt. So we're trying to work our way out of debt. Slowly. The debt is far more than we can pay off in the short term, so it's a question of whether to pay it over many years, or many many years.
Monthly, $1400 is house payment, and another $400 is student loans and credit cards. I think the rates are pretty good, but should I be trying to pay them off faster than I already am? The catch is, we are already close to the bone with expenses, and it's hard to find expenses to cut that we haven't already cut.
SAVINGS:
(Currently getting 0.80% on the bank savings account, so I don't think of that as an investment - just a place to keep emergency money.)
My employer automatically sends $280 of my gross paycheck to a retirement account, on top of which I choose to save another (token) $25 for retirement, and another $25 for the kid's college, each month. These are very long-term goals. But I wonder if it makes sense to even save these token amounts, instead of putting all that money into either the bank account / emergency fund, or paying the debt faster.
The retirement / college accounts are invested aggressively because of the long time horizon, according to the suggested investment mix of endowment manager David Swensen, a combination of index funds in stocks, Treasuries, inflation-protected Treasuries, and REIT mutual funds.
Monthly Paycheck Deductions
$280 - automatically sent to 401K
$25 - voluntary additional contribution to 401K
$25 - 529 college savings plan for baby
$125 - to flex account for medical expenses
$125 - to flex account for child care
$101 - payment on student loan, balance $17000, 2.625%, graduated repayment
$134 - payment on another student loan, balance $35000, 3.375%, graduated repayment
$100 - payment on credit card, balance $7400, 0% rate. When this rate expires, I transfer the balance to another card at a 0% balance transfer offer, for a fee of 2% or 3% of the balance. I don't charge anything to this card. I've been doing this for a couple of years and slowly paying it down. I recognize that paying the balance transfer fees amounts to an effective annual interest rate of 2 or 3 percent, depending. Obviously if they ever start charging interest on these balances, that would become the high priority to pay off.
$50 - payment on another card, balance $2500, 0% rate, same deal.
Thank you in advance for any advice.
To any young people reading this and their parents: think very very hard about taking any student loans unless you really know what you are doing!
Location: Chapel Hill, NC, formerly NoVA and Phila
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You don't mention how old you are. And you don't mention whether there is any 401(k) match. Assuming you are pretty young and that there is no match to the 401(k) from your company, I'd probably stop contributing the $25 to the 401(k) and the $25 to the 529. With that $50 per month you can pay off that $2500 loan pretty quickly. I would also throw any other extra money you have from that fluctuating income toward that loan.
I would likely do this before you even build up a 6-month emergency fund, and I know I'm going to get flak for saying this, but TEMPORARILY you have your credit card for an emergency. Here is why I say that: if you build up a 6-month emergency fund - that is pretty big. For example, let's say 6 months is $5000 for in an emergency fund, I'd rather put that $5000 toward paying your credit card debt, since you are essentially paying interest on that credit card (that 2% or 3% transfer fee), while making virtually nothing on that large chunk of money sitting in your emergency fund just waiting for an emergency.
Let's look at two scenarios:
A. You save $5000 in an emergency fund, and keep your $2,500 balance and $7,400 balance on your credit cards. Then your roof collapses and you need $5000 for a new roof, you use your $5K emergency fund, while your credit card balances are the same - totalling $9900. If you instead use that $5000 on paying off your credit cards, you now have $0 in an emergency fund, while one credit card is paid off and the second one has a $4900 balance. You have the same roof emergency and you use your credit card to pay $5000 on your roof. You still have a credit card bill of $9900. Same outcome either way.
B. Now suppose you save $5000 and put it in an emergency fund, and keep your $2,500 balance and $7,400 balance on your credit cards, but no emergency happens. You have $5000 sitting in an emergency fund and a $9900 credit card balance. If you use that $5000 on paying off your credit cards instead, you now have $0 in an emergency fund and one credit card is paid off with the second one having a $4900 balance, and you have saved money in interest on your credit card.
Note: I wouldn't do this if there is a chance of your credit card company canceling you or of reducing your credit limit.
After that first credit card is paid off, then I'd probably put some money away for an emergency while trying to pay down the bigger credit card, but not 6 months' worth - maybe 1 month's worth at the same time aggressively paying off the second credit card. If you think you have a chance of that second card cancelling you then save up 6 months' worth in an emergency before you pay it off.
All the while I was doing this, I would think of ways to earn more money in order to pay these credit card loans down faster and get you moving on putting savings away. Once the credit card bills are paid off and you have your 6-month emergency fund, then I'd start back up with the savings for retirement. I'd probably hold off on the college savings until your own student loans are paid off.
I actually have another couple of credit cards with zero balances and total $20K available credit, which I guess could be available in an emergency.
There's no employer match on the 401k, or rather, on the $25 that I choose to put in each month. The employer does match the automatic $280/month, but that's fixed and can't be changed.
Early 30s, but planning to work until I die, which, now that I say it, suggests that the retirement account may not be the highest priority. (Yes -- I have a PhD.)
The tricky part for me is separating out the gut instincts from the financial logic. It feels wrong not to have a balance in the bank savings account for emergencies; also not to be putting something extra in the 401k, or not to put money in the baby's college account. It also feels like the student loans and mortgage will be there "forever," so why try to pay them any faster? And the smallest balances (the credit cards) are also the debts with the lowest interest rate, while the largest debt (the mortgage) is at the highest rate, so what does that mean?
^^ not saying any of this is correct; it's just the gut instincts that I have, which I am trying to critically examine.
Location: Chapel Hill, NC, formerly NoVA and Phila
9,781 posts, read 15,811,722 times
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I understand that you want to have a bank balance, but how long would it realistically take you to save up for a 6-month emergency fund? I'm guessing you are talking about $15K to $20K. If you are more comfortable having some kind of emergency balance, then save some money (1 or 2 months' worth) in an account while paying off your credit cards simultaneously. Your one card is so small, just pay it off and be done with it. Then you can concentrate on your bigger debts.
I guessed you were in your early to mid-twenties, so you are a bit older than I thought. How much do you have saved for retirement to date? Do you have any other expenses that you can cut out? Eating out? Unnecessary purchases? Can you get a second job? Can your spouse earn more money? It's going to be hard to build up a big retirement fund while having debt to pay off.
You probably need to take a look at all of your expenses and see if you can cut out some things so you can get full-force paying off some of your debt and then concentrate on savings after that. Good luck!
I suggest saving up a small emergency fund (about $2000), and then paying off the credit cards asap. You have large balances on them, and you will get burned. Either with balance transfer fees, or when interest rates kick in. Call me crazy, but I would stop contributing to retirement and the college savings all together. If you don't, you are just diluting your efforts. Once the non mortgage debt is paid off, then you can ramp back up the savings for those things, and you will be able to catch up.
You just really aren't in a position to be saving for retirement right now. I'm willing to bet your future retired self would want you to stop contributing right now so you can squash this debt permanently. Also, cancel the credit cards. And I wouldn't look at doing the balance transfers anymore, it's just putting a bandage on the problem. The rationale hasn't helped you up to this point.
I would also look at trying to find a part time job, and downsize on your home. You seem to be extended with your mortgage, which is part of the problem. That's a pretty high payment for your income. If you can sell the home, and rent a cheap two bedroom apartment for a few years, you can be out of all this mess in no time.
You can make this all happen, but you have to really want it.
Pay off debts faster. Once you pay off one debt, throw that payment into another debt and "snowball" them until you've paid them all off.
Increase deposits into long-term savings accounts
Of course a larger emergency fund is better, but I think 3 months is a good medium to get you back on your feet. If you're able to, have you thought about refinancing your mortgage to a 30yr at 3.5%? That would give you some more disposable income that you can throw towards your other debts. I'd also stop the retirement account contribution until you get that debt reduced. Once you have it reduced, imagine how much you can put into that retirement account. I say forget about the compounding for now, that debt is anchoring you down.
Wow, I feel like the OP. We are in a somewhat similar situation. Everyone seems to say pay off the debt, I will have to disagree. I agree with you on the gut feelings and I have been giving this a lot of thought over the last few months. I have exactly the same debts (amounts slightly different) as you except instead of a mortgage I have a car. I also do the same 0% deal with the credit cards. I also feel that mortgage and student loans will be there forever! I think you need to keep doing what you're doing and save! I would probably do away with the extra $25 to the 401K and the 529 plan for now. Here is my reasoning based on two scenarios:
There are no issues until you have an emergency that comes with a big expense. Now if that big expense comes, such as a $5K roof, you said you have other credit cards that you can put that on. It sucks, but it won't be the end of the world. Obviously you have good credit, so you can move that $5K to an interest free credit card and I wouldn't even use the emergency fund for that, my reasoning for that follows.
The second scenario is you lose your job and are unemployed for a long time - this is my greatest fear. In this situation however, you have many options. First, your student loan payments stop - forberance. I'm assuming they are government loans and the government will work with you. On top of that they won't be able to garnish wages if you have no job. Private loans are just like any other credit. If you can't make your credit card payments or your mortgage you can walk away from these. Your credit will take a hit, but not for that long. These are all drastic measures, but something we have to think about in this economic climate.
In the case of job loss, you won't have to make your debt payments but you'll still have the cash in you savings account to survive. Now in the case none of this happens, I think once you get to maybe $20K in the savings, you can start withdrawing in some sort of intervals like $2K or $5K and paying off your cards in full. Once you get back up to $20K you make another payment on another debt. I don't know if I would personally do that if I can continue getting the 0% offers on the cards.
After the cards are done, I would worry about saving more. I don't think it makes sense to prepay your mortage or the student loans. The interest rates are pretty low and the balances are high. You might consider refinancing the mortgage though, I think current rates are below 4% and that might cut your payment. I don't have experience with this though.
You hadn't mentioned anything regarding transportation. If you have a car now with no payments that's great, but it won't last forever. At a certain point you will need to spend $$ on purchasing a new/used car and you have to think about that too. Even if your car is great, it will still need maintenance.
Why does your wife not work? I'm thinking if maybe it's because of the child, once the baby gets a bit older, she can find a job and you can start throwing that whole paycheck to the student loans. Once the loans are done start saving for the baby college fund.
Right now we are a one earner household also. When my GF gets full-time employment in her field, we plan to tackle our debt the same way I describe to you.
Pay off debts faster. Once you pay off one debt, throw that payment into another debt and "snowball" them until you've paid them all off.
Increase deposits into long-term savings accounts
Of course a larger emergency fund is better, but I think 3 months is a good medium to get you back on your feet. If you're able to, have you thought about refinancing your mortgage to a 30yr at 3.5%? That would give you some more disposable income that you can throw towards your other debts. I'd also stop the retirement account contribution until you get that debt reduced. Once you have it reduced, imagine how much you can put into that retirement account. I say forget about the compounding for now, that debt is anchoring you down.
I agree completely with oneasterisk. Congratulations on being on step 6. I am currently on step 2, being tied down by my student loans. But I am throwing everything at them, and will be done soon. I used to think I would have the student loans "forever", but after following Dave Ramsey, I am now on track to paying off $40k in student loans in a year's time.
I suggest saving up a small emergency fund (about $2000), and then paying off the credit cards asap. You have large balances on them, and you will get burned. Either with balance transfer fees, or when interest rates kick in. Call me crazy, but I would stop contributing to retirement and the college savings all together. If you don't, you are just diluting your efforts. Once the non mortgage debt is paid off, then you can ramp back up the savings for those things, and you will be able to catch up.
You just really aren't in a position to be saving for retirement right now. I'm willing to bet your future retired self would want you to stop contributing right now so you can squash this debt permanently. Also, cancel the credit cards. And I wouldn't look at doing the balance transfers anymore, it's just putting a bandage on the problem. The rationale hasn't helped you up to this point.
I would also look at trying to find a part time job, and downsize on your home. You seem to be extended with your mortgage, which is part of the problem. That's a pretty high payment for your income. If you can sell the home, and rent a cheap two bedroom apartment for a few years, you can be out of all this mess in no time.
You can make this all happen, but you have to really want it.
I have to disagree with you on a few things. If you know how to manage debt and these 0% offers, it's actually a great thing. I've been doing it for over 10 years and not once have I been burned.
I have a $11K on one credit card that I'm paying down at 0% and I have $15K in the bank. No way I'm going to use that $15K to pay the credit card off. It just doesn't make sense. If I'm unable to work or to find work for whatever reason the credit card company is going to have to deal with it, but I'll still have my $15K.
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