Should you always repay debt before saving?
Not long ago, my wife and I finally paid off our credit card debt. We shared our success with our friends and family and that prompted many of them to ask whether they should save or pay off debt and whether we made the right choice in paying off our debts.
The obvious answer comes from mathematics. If your interest on debt is higher than the return you can get on your money in an account or investment then you should always prioritize debt repayment. But we are humans, not computers, and if we always optimized we wouldn’t have gotten ourselves into bad debt to begin with!
If your interest on debt is higher than the return you can get on your money in an account or investment then you should always prioritize debt repayment.
Many people have an issue with strict debt repayment regimes where one does not build any savings. It can feel like you are paying into a never ending pit. We humans love the feeling of progress. Seeing your balance shrink does not for the most part give the same excitement as seeing your savings grow. If you aren’t excited about what you’re doing it’s very easy to give up.
So what should you do? What should you consider when making the decision? I believe the answer depends on the type of person you are. Are you risk tolerant? What are your goals? Do you have any expenses coming up that might be better to pay in cash? Will you be able to withdraw funds from the account you are repaying?
Finding what works for you
For my wife and I cash flow was our biggest priority. We weren’t really bothered by the amount of debt we accumulated as much as we were bothered by the fact that our debt payments were a big monthly expense. Paying off our debt didn’t put us in large risk because we had access to the very credit cards we were paying off. If shit hit the fan, we figured, we would use some of the available balance to cover the bills. We dreamed of being debt free not due to stress or sleepless nights, but because we envisioned a life where the payment money could go to entertainment, travel, gifts etc. This lead us to deciding to pile all in on debt repayment.
But what if your financial picture is different? Things can get tricky. A great rule of thumb is to save up a month’s worth of bare bones expenses before you start going crazy and dumping every spare dollar into debt repayment. I didn’t follow that rule and it caused me a few stressful nights. That’s your back up. Once you have that you need to think about your priority in life. Singular. Priority. What’s most important? If your priority is having fun with family and friends then take that into consideration. Don’t make a debt repayment plan where you never go out and get a second job. You will either self sabotage and fail or grossly not enjoy the experience. Our priority was to have freedom, to not be bound to a job or a place because of financial obligations. Work to live not live to work.
Working with your priority
Once we figured out what our priority was we went balls to the wall with our effort. We moved to a smaller cheaper apartment, cut out a lot of expenses and promised ourselves to double the payments we were making every month. I covered our cards in water and hid them in the freezer to the amusement of my wife. We put every extra dollar towards repayment and did not build up any savings before or during our repayment plan. This was all in line with our goals. If your priority is building a retirement savings account then get started while you are repaying your debt. I know people all over the internet will say that it does make mathematical sense, but if that’s whats important to you then you should do it. You will feel better about the entire process and increase your likely hood of sticking to it.
It’s not always easy
We made mistakes. It’s hard to count every penny and be relentless about minimizing spending long term. If I did everything optimally we would’ve paid off our debt months earlier. But I didn’t let myself be discouraged by it. When the month I initially predicted us to be debt free passed by, and we weren’t even halfway there, I didn’t throw in the towel. It was an opportunity to reexamine our habits, behaviors and goals.
Re-framing the problem
Personally, I did not want to accelerate our debt repayment. I was looking to save to invest in cash flow generating assets. The saving part was hard because of our minimal payments on the credit cards. All of a sudden one night on my way home, I stopped thinking about our debt as debt and instead starting treating it as an investment. An investment that will cash flow the $400+ in minimal payments we were making if only I paid it off. That mindset which really helped me. It made it seem to me as if I was saving for something tangible, not paying off things I bought in the past.
After managed to pay everything off we let ourselves relax a bit. We still had no savings, but we felt like we deserved a few treats after months of saying no to ourselves and friends. Some of those expenses went onto the very cards we worked so hard to pay off. As long as we have the funds to pay our balance down and not be charged interest its OK. We feel like we can celebrate a bit before we start working on our next financial project. You can celebrate milestones as well. As long as rewarding yourself doesn’t bring you back to square one.