Build Savings or Pay Off Debt – Which Comes First?

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.

Build Savings or Pay Off Debt - Which Comes First?
Build Savings or Pay Off Debt – Which Comes First?

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?

  1. No one can be effective in carrying out any plan while being broke
  2. 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
  3. 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
  4. 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
  5. 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?

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40 Responses to Build Savings or Pay Off Debt – Which Comes First?

  1. Kevin, I like your angle, but I have to say that I don’t necessarily agree that it’s a lack of savings that forces people into credit card or debt problems. Of course, that doesn happen to some people where there is an emergency of some sort and they don’t have cash and have to rely on credit.

    But I think that is a slim minority. I think the reason most people are in debt is because they simply can’t control themselves. They want what they want when they want it – to the detriment of their financial health.

    Either way though, steps need to be taken to get an emergency fund in place and an intense plan to knock that debt out! I think partial money to both debt and savings is probably best.

  2. Jason, I fully agree that lack of control is the true root of debt problems. But while most problems do have roots deep inside us to faulty thinking, bad habits, etc, we need a mechanical process that will enable us to overcome the internal obstacles.

    Gaining control of spending is the key to all things financial, but where do we go with that? Is it better to use that control to build some savings, then pay debt, or to attack the debt first and foremost?

    Having a savings cushion tends to deal with a lot of the emotional problems surrounding debt–the feelings of being out of control, of panicking or of just plain feeling lost. It becomes a visible and tangible evidence of our ability to actually conquer a nagging debt problem.

    Which is easier for a financial convert to do, payoff $30,000 in plastic, or build a $10,000 savings account? It’s a matter of winning the smaller battle before taking on the bigger one.

  3. I doubt anyone who hasn’t already changed the way they view credit, will manage to save the money necessary to pay off their debts in large chunks. Meanwhile they are paying the minimums on credit card debt, which means the debt is likely not getting any smaller. Lets say the minimum is 2%, if your interest rate is 12% a year and most folks is higher, you are gaining a whopping 1% on your debt, yes, in only 100 months you will have it paid off. Changing your habits is necessary, changing it so you have money left over after all the bills is the key, saving it is the equivalent of putting it in the mattress at current rates, you are better off paying off some of the principal along with the vig, so at least you are bailing yourself out of the hole.

  4. Vitaeus – Thanks for dropping by from the Daily Java!

    I agree with you, but much of peoples debt problems are psychological. We’re trained to think as consumers, rather than as savers. Debt is a natural outgrowth of consumption, or really over-consumption. So we need to become savers before we can even think we can eliminate debt.

  5. When Nathan Bedford Forrest found himself flanked by Union cavalry, he uttered the famous command to his horsemen, “Split up and charge both ways.”
    I think the same command applies here. There’s no reason you can’t work on your debt while starting to save.
    I think there’s a psychological buoy when you see you have cash saved. Even though, technically, I think that money would be better suited applied to a high-interest loan.

  6. Matt – ?Split up and charge both ways.? That’s kind of what needs to be done no matter which way we go!

    Numbers aside, I tend to think we’re better from a human perspective to tackle one challenge at a time, in this case save or pay debt. The ability to do both really would depend to a great degree on the level of income. If you’re high income/high debt, you might be able to rearrange your finances to do both. But if you’re in the modest income range, divide and conquer may be the only workable course.

    I do believe that if you’re TRULY determined–as in down to the depths of your soul–that you’re going to get out of debt, that going full tilt at debt payoff can work. If you’re that determined, the “how” will work itself out. What I question is the ability of most people to maintain that level of intensity and commitment over the long haul. That’s why I think that having a cash cushion is essential for most people.

  7. Great insights Kevin!
    I agree with “split and charge both ways”, but it has to come with lifestyle change. For us, debt is a pain and since we are hurting are attacking it furiously and aggressively; so we do not have savings per se’ but we have an emmergency fund that can take us three months.

  8. Joseph, if you have 3 months living expenses put away, and now you’re attacking your debt, then you’re living what’s in the post.

    I’ll bet you sleep a little better knowing you have a cushion, and that has to improve productivity at work, and focus on the debt!

  9. I agree. If one is in substantial credit card debt, they should allocate funds for savings, and not use their total dispensable income to pay off high interest debts. When one has money saved, it can certainly be a moral booster.

  10. Credit Card Relief–That’s a big part of it, the emotional side. A healthy bank balance gives you confidence from which you can accomplish things that would be impossible, or at least substantially harder, if you were broke.

  11. I cant seem to save money while I still have payments…. and I cant get rid of payments if I am saving… so I am stuck. It’s frustrating at times… not making much progress lately… my income is too low. And things are so expensive.

  12. Arthur, that’s the dilemma a lot of people are in. That’s why I think divide and conquer will work better for most people. Choose one, master it, then go after the other. I think savings is the one you choose first; with a healthy bank balance, taking down the debt will be that much easier.

    Check out the last link in the post for some ideas on how to get that going.

  13. I used to freelance. It was MANDATORY to maintain a 6 months living stash in addition to my savings account. The earlier you learn the habit of saving the better. There are always expenses of some kind – but its hard to rebound a savings plan if you use it to pay off debt. NEVER stop accumulating your savings and pay off debts as quickly as you can.


  14. Lee, absolutely if you’re freelancing, but also self-employed or in commissioned sales. Income isn’t steady in those workstyles most of the time, and you need to be able to float yourself during the lean times, or you’ll be forced to borrow.

    But it’s also increasingly important for salaried individuals as well. The job market is far too unstable to make any assumptions about income continuity.

  15. I would say that regardless of one’s debt, grabbing the matched 401(k) if your employer offers it is not to be missed.
    That said, there are some who want an emergency fund, and others who would rather put every dime toward the debt. I’d say that whatever works is what one should do. What’s most important is to get to the cause that put you in debt in the first place.

  16. Joe, So right, there are no hard and fast rules as long as you’re heading in the right direction. The idea of establishing savings in advance of debt payoff is actually a suggestion for getting finances under control. Once you have a nest egg, there’s something to “protect” that can provide a sort of launching pad to attack the debt from.

    No doubt however that if there isn’t a plan to control spending and allocate funds toward savings and utlimately debt, any plan is doomed to failure.

  17. Great post! For so long I thought the was out of debt was to pay off my debt first. Which didn’t work for many years.

    Unfortunately, I was recently faced with an emengency that required several thousand dollars that I had to borrow, which has put me back in debt.

    So now my plan is to work on paying off that debt, but also to save at least an equal amount until I have 3 months expenses covered.

    Its a good feeling to have a bit of $$$ in the emergency fund!

  18. Mike, that good feeling from having some money put away is what it’s all about. We often underestimate the psychological side of personal finance. When you have money saved, you can deal with a lot that you can’t when you’re broke.

  19. Great article. Most of the advice I have heard in the past said to pay off the debt because you are paying interest on it; “if you want to make 20% of a return on your money, pay off your credit card debt”. But what you suggests make a lot of sense. If you are truly able to change your habits and actually start saving, having a cushion of cash on hand for emergency will help keep someone from having to take on more debt in the process of getting out of debt. Also, in building those reserves, hopefully, people will take a closer look at where their money is going. A lot of the people with debt problems are used to spending more money than they take in. Saving up for 6 months reserve while not taking on more debt should force a life style change. If they can make the savings goals then they can do some serious debt busting!

  20. Precision Team – That’s the Part B of savings. It requires us to live beneath our means, which is the exact discipline needed to payoff debt.

    The reason why savings is superior as the first objective is that it frees the debtor from needing to rely on debt, and until that addiction is broken, getting out from under is probably not even doable.

  21. The ability to do both really would depend to a great degree on the level of income.Thanks for the info. I learn a lot. I think somebody should know about this aside from me.

  22. There’s no doubt that this is great advice for young and old alike. Balancing the load between debt and savings is a bit of a hard lesson to learn, but both need to be managed for any potential financial calamity. Great write up!

  23. I think you make some very good points. Psychologically, your money will have more meaning if it is in the form of savings first. Then it puts debts and spending in their proper perspective. If you have no savings and put it all towards debt, then you feel like you have no stake in anything until it’s all paid off. Thanks for the post.

  24. DebT – “If you have no savings and put it all towards debt, then you feel like you have no stake in anything until it?s all paid off”–very well put, that’s actually what I was going for. Not having a “stake” in your finances is a major reason someone might effectively quit and allow themselves to slip hopelessly into debt. If things get bad enough, there’s a sense of having nothing to lose/protect, and by then it’s really hard to get back in control. If you start by building a savings account, you’ll be building a stake, maybe for the first time.

  25. I believe one should do both. That way if a car repair is needed, at least there is some kind of money to put towards it-instead of charging the whole thing. There are so many things that can go wrong in life. I was deep in debt and it took a complete renewing of my mind for me to see that I was a slave to debt. Every thought, decision and direction my life took was based on my debt. A person needs to understands that freedom from debt brings liberty to choose where you live, where you work and how you spend your time.

    I enjoyed your post..

  26. Debt Relief – Thanks for reading! Excellent points on how debt controls your mind and actions. Most people buried under it are probably only remotely aware of that.

    I also agree that it takes 100% commitment to eliminate it if you’re deep in. Part of the problem with debt is that it’s so easy to get into, that we might expect that it will be equally easy to get out of.

  27. You don’t need to have savings, per say, but you do need an emergency fund if you suddenly find yourself without an income. So in my mind, in order of priority, it goes 1) emergency fund, 2) pay off debt, 3) savings/investing.

  28. CCR – I fully agree with your priority. The emergency funds eliminates the need for debt, so it’s foundational. Then savings and investment make no sense unless you’re out of debt, especially credit cards. Having savings AND debt functions something like a margin loan, and those can be disasterous.

  29. Most people don?t track what they spend and may not realize when expenses add up to more than their budget can handle. To keep track of what I spend, I put what I think I should spend for the month on transportation, food, entertainment, etc., into envelopes. This helps me avoid buying bags I don?t need, and what?s left over goes into saving.

  30. RP – That was the budgeting system my grandmother used for over 90 years, and she always had money and never wanted for anything. I think that the more complicated our finances, the easier it is to convince ourselves that we’re better off then we really are. So it is with credit cards and even checking accounts. You never know exactly how much you’ve spent until the end of the month. With envelopes, emptiness is the ultimate recognition!

  31. I think there?s a psychological buoy when you see you have cash saved. Even though, technically, I think that money would be better suited applied to a high-interest loan.

  32. The Build Savings or Payoff Debt Which Comes First?, I think it depend one the person how needs it and it is a thing which totally depend on the time needs,

  33. Dept is something that will not just go away. You have to work on it. If you putt your mind to it and work real hard it can be done.

  34. I believe this article fails to address the basic reason a person might get into debt in the first place: it is NOT a lack of savings, it is a lack of self control. Stop buying things you don’t need! As soon as you cut your spending, you can begin to save.

  35. Phil – There’s some truth to what you’re saying, but we all need mechanical steps – a redirection plan, so to speak – in order to handle things in a different way. It may be a matter of self-control, but once you’re on the debt treadmill, it becomes something very different. At that point, a different money plan is needed.

  36. Being in Debt can be quite embarrasing and scary. I tried to do the savings then debt path originally. In graduate school, I racked up over 10,000 in credit card debt and have managed to hide it from everyone. In the past 5 years since graduate school I have managed to get thousands of dollars worth of savings and have managed to spend it all, being out of work for 3 months, having to move cross country twice for work. Having repairs on my house and car. I was paying more than the minimum, but it never seemed to make a dent in the pricipal.

    Recently, I got over my embarrasment… I lived off of 14,000 income for 4 years in graduate school, and only ended up 10,000 in debt (granted it would have been much better as a student loan) but I can’t change that now. It is nothing to be embarrased about.

    So my plan. Pay bills, put 10% of my net income into savings and pay 15% (which is over the minimum payments) towards the credit card debt. This is done through automatic payments. I set up a spending account, a housing account (all recurrent bills), and a savings account all at the same bank, so its easy to track. So far its working out well. Anytime I get a large sum of money (e.g., tax return, christmas present), it goes directly towards the credit card debt and I tell myself, “its not my money to spend.” On this plan, It will take me 3 years to pay off my debt, which isn’t bad considering my income.

    After talking with my family, I opened up two new credit cards, transfered the balances at 0% APR for 18 and 15 months and then 11%APR and closed the old ones with a 21% APR. I have also taken on a second job and have been applying ALL of the money to my credit card debt. At this rate I should have everything paid off within the 10 months (28 months without the second job).

    In the past 4 months, I went from a revolving debt cycle, to having a reasonable time frame in which I will be debt free.

    Sometimes its a matter of swallowing your pride getting over your embarrasment and fear and structuring your life and bank accounts to where you don’t have any wiggle room. Its a hell of alot easier to force yourself live off of Ramen noodles and not go out to dinner for a few days until pay day if your spending account says $50.00 than if it says $500.00. For me, its a matter of tricking myself into believing I have less money to spend than I really have.

  37. Wow that’s real trench warfare on your debt! But it’s an inspiring story. You’re doing what ever you need to to pay off your debt, and that’s what’s really making it work. Pride does have a lot to do with it. If you can face that you’re halfway there.

  38. I totally agree with the concept of having something in savings while paying off debt. First hand experience…many years ago we had a few thousand in credit card debt and I would put every spare penny toward that balance. Then when something happened and we had to spend a few hundred dollars unexpectedly, we had to charge the expense to the credit card because we didn’t have cash on hand. It becomes a vicious cycle. Being able to pay cash for some things really helps keep the card balance decreasing.

  39. Hi Kathy – Exactly, it becomes a game of three steps forward/two steps back. That can make you give up! The other issue is psychological. Having to borrow money again (after paying down debts, which is never easy) is an emotional drag. You start to feel that you’re never going to get out from under. That’s why I think getting out of debt has to start with eliminating your dependence on it, and the best way to do that is to become a saver. Once you can build a life that no longer depends on credit, you can make it go away for good.

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