Savings vs. debt: What’s your priority?

by Karen on August 17, 2008

Most personal finance gurus agree on a wide range of money topics, but there’s one that causes continual controversy: When creating a budget, should debt or savings take precedence?

When we set our first zero-based budget using mint personal finance software,  we struggled with this one. Right now we’re focusing on paying down credit card debt. As of November we’ll be completely credit card debt free, and that money will then go toward a sizable chunk of student loan debt.

I’ve read “The Total Money Makeover” by Dave Ramsey, and I think his plan makes sense for people who are settled into a home where they plan to stay long-term. Unfortunately, that’s not the case for my husband and me.

We decided that focusing on debt isn’t the best option for us. Instead, we figured out how much money we have left over at the end of the month once all of our bills and living expenses are paid. It’s about $500. So we’re devoting $250 to our savings and $250 to student loan debt.

I know, this might not make sense to some of you. However, all but 1/3 of our student loan debt is low-interest federal loans. The interest rate for those is 4%, which isn’t much higher than the 3% interest rate on our ING savings account.

I briefly considered putting the high-interest private student loan debt before savings. If we devoted all $500 of our extra money at the end of the month to those loans, we could pay them off in 3 years. After that, if we continued to devote $500 a month to paying off the federal loans, it would take another 8 years to pay those off. Of course, I’m hoping that as our income increases, we’ll have more money to put toward debt so we’ll be able to pay them off faster.

The problem is, we need to save to pay my husband’s tuition for the next two years so we can avoid even more student loan debt. With so much to save, we really can’t afford to leave our savings alone while we get out of debt.

So for now we’re splitting the difference. Aside from the minimum payment for the federal loans, all $250 of our debt money is going toward the private student loans until they’re paid off. When those are paid off, we’ll start paying off the federal loans.

It’s not completely equal, though. At the end of the month, unexpected income or surplus money that we didn’t spend goes toward credit card debt for now. Once we’re out of credit card debt, our savings accounts will take precedence and extra income will go there.

The $250 budgeted toward student loan debt is fixed until further notice. If our income permanently increases through a raise or other source, we’ll reconfigure this plan. Once my husband is finished with school, bringing in a full salary, and we’re settled in a city where we plan to stay long-term, we’ll rent a cheap apartment and start attacking our debt. We don’t plan to start saving a down payment for a house until those student loans are out of our lives.

The point is, no solution is one size fits all. This is what works for us right now, but we’ll adapt our debt to savings ratio as our lives and plans change.

What are your thoughts? Does debt or savings come first in your budget?

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Building up savings while getting out of debt | Sense to Save
August 19, 2008 at 4:39 pm

{ 6 comments }

1 Kacie August 17, 2008 at 12:55 pm

I think it makes absolute sense to do what you’re doing. Dave Ramsey is cool, but his advice isn’t one-size-fits-all, as you’ve said.

We’re focusing on building our savings now, rather than pay off our last debt (car loan). We just feel like we’d be better off right now to have as much liquid cash as we can.

What’s your interest rate on your credit card? What about getting that thing paid off superfast and then redirecting your attention to the student loans?

2 Karen August 17, 2008 at 1:00 pm

The interest rate on our credit card is 0%. We transferred the balance on two high-interest cards last December and figured out how much to send them every month to pay it off in 12 months before the 0% promo period ends.

Since our income was so low up until two months ago and the interest rate is 0%, we decided to take our time paying off the card so we wouldn’t be overextending ourselves.

We could afford to pay it off sooner than November now, but I don’t see the point since we’re not paying interest on it, ya know? I’d rather put the money in our savings account where it can earn interest.

3 tiffanie August 17, 2008 at 6:10 pm

We focused on savings until we had a $1500 small startup emergency fund set. Then I switched and the $200 I was putting into savings now goes towards credit card debt, along with any other miscellaneous money that comes in, plus the regular amounts we were used to paying. This will get our credit cards paid off in about 2-3 years (over $20k), then we’ll start focusing on the student loans and car loan.

Once I get a job, we’ll probably start putting a little back into savings each month to work towards our bigger goal.

So for us, we’re focusing on debt before savings. At least where we’re at now with the income we have.

4 Garden Girl August 18, 2008 at 10:53 am

Well, the question I would ask is how much is enough in savings? After you have reached your savings goal will you then be full-on attacking the debt? That seems reasonable and wise. Are you still racking up debt on the credit cards? It can be very dangerous not to be paying those off every month. Because once the introductory rate is over you may find yourself with a balance that you can’t pay off (like perhaps something happened that took all of your savings to fix, etc.). I don’t know what degree your dh is going to have but I hope the salary will be phenomenal!

I do believe that the borrower is slave to the lender. Kick those lenders to the curb! But you need the cushion of some savings in order to do that (make sense).

I don’t know you but I think you and your dh are doing a great thing about being this serious about your finances.

5 Karen August 18, 2008 at 10:58 am

Thanks for the comment, Garden Girl! We are absolutely not racking up debt on our credit cards anymore! I hope you’ll browse around my previous posts to see what we’ve already accomplished, but we’ll be credit card debt free in November and I don’t plan to ever carry a balance again.

As for our savings goals, we’re kind of saving indefinitely for the time being until we’re settled. As I said in the post, we have tuition costs, moving expenses, and emergency savings to build. In my opinion, at this point in our lives with everything we have coming up, it’s not possible for us to save too much. SO rather than setting our goals at an amount, we’re saving until we’re settled into a city where we plan to stay put (which will probably be the next city we move to in 2 years), and then we plan to get our emergency savings fully funded then devote every extra penny to student loans!

Thanks again for the comment, and I hope you come back soon!

6 Karen August 18, 2008 at 11:00 am

P.S. My husband will be a college professor when he’s all done. We’re hoping he’ll have a good salary, too! :)

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