How much should you save before you pay off all your debt?
According to the Dave Ramsey method, you should establish a $1,000 emergency fund first and then put as much money as possible toward your debt until it is completely paid off. I’ve never felt comfortable with just having a $1,000 emergency fund. But what I have found is that we would save a lot of money and then make one large payment toward debt.
This happened a year and a half ago, when we had saved $8,000 in cash as an emergency fund when we knew my husband was not going to be working for four months. The $8,000 was supposed to cover his paycheck for those four months, in addition to any school expenses we would occur while he was in the fire academy.
We made it through the four months without having to dip into our savings at all because we lived so frugally. And at the end of those four months, I threw $4,500 to pay off my car loan. It was glorious.
We now find ourselves in the same situation. For the past six months, we have been saving up for a house down payment. We have no intention of buying a house this year–most likely not even next year. But because houses in our area cost upwards of a half million dollars for a simple three-bedroom home (we live in southern California), we figured the sooner we started saving the better.
We have now saved $11,700. The remaining debt of my student loans is $12,340. Should I use all the money to wipe out my debt within the next month?
The Pros of Paying Debt First
- No longer having to pay interest. My interest rate on my student loans range from 0% to 6% (with the majority in a 4% range). Our savings account only brings in about .5% interest. We are losing more money on interest than we are gaining by having the money sit in our savings account.
- We would be debt free a lot earlier than we had planned for. At the current rate, we’re making excellent progress, but we still wouldn’t even be close to being debt free until maybe the end of 2014, and that’s being hopeful.
- We would free up almost $300 a month by paying off all my loans now. We could add the $300 to our normal monthly savings of $1,000, bringing our monthly savings to $1,300 every month. If we start this in July, we would still be able to save $7,800 by the end of the year.
- We could devote money to other things. I currently use a hefty chunk of my side hustle income to pay off my student loans. If I contributed this money to our house down payment fund instead, we would most likely be able to save an additional several thousand by the end of the year as well.
The Pros of Putting Savings First
- Security and comfort. Having a large savings account is definitely a security blanket. It feels good to have that money there, knowing you can depend on it for whatever reason. But when you take my security blanket away, it makes me feel uncomfortable and actually motivates me to ramp up my savings again….which I guess could then turn into a “Pro”.
It seems to me there are more pros for paying off debt first than pros for putting savings first… what would you do in our situation?