Why Would You Save When You Are in Debt? Because You Have to…

Frequently cited as a reason to throw up your hands and not save, the attitude of “I have so much debt, why would I save?” could ruin you financially. Let me be clear, you always need to save for the stuff that happens in life.

What would you say I if said, “I have a 30 year mortgage at 3.25% so I cannot save any money until it’s paid off.” Would you think I was crazy? I would. You must save. All. The. Time. Sorry, it’s not what you want to hear, I know, but it is true. What happens during that 30 year mortgage if the car breaks down, the roof leaks, you need an emergency root canal or other unforeseeable events that are worse. You would have to charge them and thus you would be on the slippery slope of credit card debt.

There are different kinds of debt. Debt that is paid back over long periods of time like a mortgage or student loans with good rates and reasonable terms are different than credit card debt or some other type of consumer debt, which usually has high interest rates and possibly fees. A good solid car loan is somewhere in between.

For long term debt (duration greater than 5 years), you just want to make sure you have a good payback plan, interest rate and terms (meaning no fees for early payback, etc.). Payback of this sort of debt, i.e. mortgages and student loans, should be considered an expense over the long term and you should ABSOLUTELY be saving while you pay long term loans off.

Think about the extreme example. If you get a 30 year mortgage and have 20 years to pay back grad school loans and you are 30 years old, would you still want to save for retirement during the time your paying those debts back. HELL YES!!!! In fact, if you do not, you will probably be eating dog food in your dotage. Regular savings is just like retirement. You will need it at some point, so save.

Now, let’s look at a few of my savings rules

  1. Do not rush to pay off debt until you have a Rainy Day Fund ($1500 for renters and $3k for owners) AND at least ONE MONTH of Emergency Savings for the big 3 (divorce, disability or job loss). One month is equal to one month of your household expenses.
  2. When your Rainy Day Savings and AT LEAST 1 month of Emergency Savings are in place, make sure you are contributing 15% total each year for retirement if you are over 35 years old. This INCLUDES your employer contribution.
  3. THEN, and only then, can send any extra at the end of the month, tax refunds, annual bonuses to your credit cards. Generally, I advise people to split the extra amount they have between debt pay down and savings until they have at least 3 months of Emergency Savings. When you have at least 3 months of Emergency Savings, use the extra to pay credit card debt off exclusively.
  4. Do not worry about student loans AS LONG AS you can manage your monthly payment and you are on the optimum payback plan for your life and career. They do not affect your ability to get a mortgage as long as you can adequately manage the payments each month.
  5. Do not rush to pay off your mortgage early unless you have 6 months of liquid savings for Emergencies, a Rainy Day Fund, retirement contribution at 15% at least and you are consistently saving for college (if you want to help your kids with college). Then go ahead and make extra payments. Otherwise, do not rush.

All this anti-debt propaganda is not helpful. Credit is leverage. It helps you buy a home and build equity before you are 70 years old, it helps you go to school to earn more. It’s only bad if you abuse it and incur credit card debt at high interest rates or otherwise over extend yourself. If you’ve already done that, trim spending, make sure you are saving appropriately, and start paying it back as fast as you can.