Newsflash: You can’t get out of debt until you stop being broke! Some argue that if you’re in debt the priority needs to be to payoff your debts before attempting to build savings. Many call for the establishment of a small emergency fund—typically $1,000 — to handle contingencies, and then to pour all extra funds into the pay down and eventual pay off of debt. Only when your debts are paid will you have the cash flow to truly build substantial savings.
While there is some merit to that advice, I believe it fails to address the basic reason a person might get into debt in the first place: a lack of savings, forcing the use of credit as a savings substitute.
Until that cycle is broken, it’s doubtful you’ll ever pay off your debts or accumulate substantial savings. Life has a way of throwing contingency after contingency at us and unless we’re fully prepared to deal with that reality, getting out of debt is little more than a fantasy.
The vicious cycle of debt
I think most people underestimate the deep power debt holds over the debtor, and we often assume it’s simply a matter of a) stop borrowing, and b) payoff your debts. If only it really were that easy!
If you’re experiencing credit problems, either in the form of increasing debt levels or more frequent delinquencies, you’re probably also aware of one or more of the following:
- You probably don’t—and maybe never did—have any substantial savings
- Your credit lines function as your savings account
- Your debt levels have risen steadily over the years, despite the fact that your income has also risen
- You’ve generally been overly optimistic in your thinking, tending to assume higher income and lower expenses than has usually been the case
- The parade of “unexpected expenses” seems to be intensifying
- You may have developed a syndrome I refer to as “debtors optimism”—much like a gambler, the debtor assumes luck will be his savior
- You’re making the minimum monthly payment on your credit cards, promising yourself you’ll get more aggressive with payments later when…
Now a fat savings account won’t make all of these issues magically disappear, but it is a fact that a cash rich position does tend to make the ride in life a good bit easier, and this is at least in part because of the discipline having savings imposes on us. Just learning to live beneath our means—what ever those means may be—can be life transforming.
Make it a priority to build savings
Why is it in your best interest to build savings before tacking your debts?
- No one can be effective in carrying out any plan while being broke
- While we’re trying to focus on paying off debt, bills are still rolling in, each one having the potential to force us to abandon the pay off effort in favor of putting out the immediate fire
- Savings give you room to breath! Unless you have margin to fall back on when unexpected bills come in, you’ll panic. Panic is fear, and fear is in no way solid ground from which to conquer your debt problem or even to live life
- Accumulating savings requires living beneath our means, banking windfalls and developing additional income sources — all of which will help in the later effort to pay off debt
- In order to save, we must develop a more a realistic assessment of our finances; debtors optimism (or any form of optimism) won’t get the job done
Three to six months of living expenses in the bank should be the goal. I’m sorry, but the $1,000 emergency fund won’t cut it—that’s little more than a nasty car repair bill today, and how unusual is that? One “emergency” and you’re back to being broke.
Once you have three to six months put away it’ll be time to tackle the debts. But even once you do, you should continue to increase your savings if only at a slower pace. After all, the same contingencies that put you in debt in the first place also have the potential to drain your savings.
Maybe it’ll take longer to pay off your debts this way, but if you have a cash balance to fall back on in emergencies you’ll have the time you need. In fact, one thing you may want to consider is a divide-and-conquer strategy in which you ignore your debts beyond making minimum payments in favor of maximizing savings.
Once you have the minimum put away (three to six months living expenses) continue saving until you have enough excess to pay off one of your loans entirely. You can continue this strategy of picking off one loan at time until all are paid—and throughout the process you’ll never have been broke!
If you agree that savings is the place to start before paying off your debts, please read Start and Grow Your Nest Egg Even If You’re Broke for some ideas on how to get started. Once you have a few months worth of living expenses stashed safely in a savings account you’ll begin to feel better about your whole financial situation, because it will be better!
Which way do you think is the better way to get control of your finances, build your savings first then attack your debt, or go right for paying off the debt and build savings later?