Should I Make Extra Debt Payments or Save? (Part 2 of a 3-Part Series)

January 29, 2015

Connect Member

CFP®, CRPC®, AAMS®, Certified Financial Planner™ practitioner, Founder & CEO Financially Wise Women

financiallywisewomen.com

“Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.” — Will Rogers

Boy, oh boy, Rogers nails it on the head with this quote. Debt affects a lot of Americans. We live in a society where debt is a way of life. It’s easy to obtain — and therefore can quickly get out of control.

I meet with a lot of people who want to learn the best way to pay off their debts, while saving for other goals at the same time. Of course, the solution is different for everyone, but a good rule of thumb is that you need to do both.

Let me explain: When working on debt reduction, many people lean toward putting all of their extra cash toward additional debt payments, because they think this is the fastest path to become debt-free. And sure, it’s instantly gratifying to cut your debts by large chunks at a time. But when you put all your available cash toward additional debt payments, you won’t be able to build your cash cushion up to a healthy level.

Without a cash cushion to cover inevitable, unforeseen expenses, you may end up using the same credit card you’ve worked so hard to pay off. It’s a catch-22.

Instead, split up your excess cash and allocate some toward paying down debt and some toward building your cash cushion. By following this strategy, you will slowly begin to untangle yourself from your debt and build up a substantial emergency fund.

Let’s see it in action: Say you have $300 left over every month to save or use toward debt reduction. There’s no tricky formula — simply divide it in half, assign $150 toward additional debt payments, and put the remaining $150 into your savings account. This way, you’re building up your emergency fund while still paying down your debt. Of course, working with a financial planner will confirm a suitable allocation breakdown for you and your goals. 

Tune in next month for “Which is the Better Method for Reducing Debt? Snowball Method vs. Avalanche Method,” Part 3 of the Debt-Free Living Series.

Brittney Castro is a member of the DailyWorth Connect program. Read more about the program here.

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