Guess what – Paying off debt at an accelerated rate can be harmful to your health… More than that, you may not be making the best decision for your financial future. “Why?” You ask – Being debt free isn’t the only mark of financial success. In fact, I’d argue that your saving goals can be significantly more important than being debt free…
Depending on your specific situation.
I met with our accountant last month, and throughout the first half of the meeting, I kept reinforcing a few of our current financial goals. “By throwing an extra $X at this loan, we’ll be able to knock that loan out 2 years sooner…”
I was focused on getting rid of a few of these debts we have as fast as we possibly could. And for a half hour, I lost sight of the bigger picture.
My accountant would humor me as he’d nod and then move on to the next topic. But eventually, he stopped me and said something that shocked me back to reality:
“Once you pay your extra money toward the debt, now you have to ask the bank for your money back.”
I literally stopped the meeting and said, “I need to write this down – I’m going to write a post about this… By the way, you’re 100% right. Thanks for the reminder.”
What he meant with that well-placed statement is that once your money is paid toward reducing your debt, you’ve effectively eliminated any other option that cash could be used for. Emergency fund, retirement, buying a home, starting a business, … Anything.
So now, if you decide that you want to open up your own dental practice, for example, you’ll then need to ask the bank for your money back. And guess what – maybe they’ll give it back to you and maybe they won’t, but if they do – they’re going to charge you for it… Again.
Let’s dive into the weeds and examine this decision: prioritize saving goals or paying off debt
Exactly what money are we talking about when deciding to save versus paying extra toward debt?
This conversation is centered around money you have remaining at the end of the month – after all of your other budget items are satisfied. I like to refer to this chunk of change as “progress money” because if used intentionally and in the right way – this is the money that will allow you to achieve your financial goals.
I’m not talking about not paying off credit cards, missing a mortgage payment, or even budgeting less for your monthly grocery spending… You create your budget independently, and when it all shakes out – your progress money is what’s left over.
So savings goals are now the priority, right?
I’m not there quite yet. Before you start saving at an impressive level, we need to make sure any bad debts are allotted a significant portion of your progress money first.
Anything with an interest rate over 7% (in 2018’s economy)
I don’t care who you are or what your goals are – if you’re paying the minimums on a $10,000 credit card bill that’s racking up 23% APR… You’re not making progress. And that situation will come back to find you – it’s just a matter of time.
I don’t think you’ll find too many sane people to argue that point with me. Bad debts need paid off – period. Like right now. OK – sweet. Let’s move on.
Now we’ve come to the crossroads
Nooo – not the amazing Bone Thugs In Harmony jam from my childhood…
What I’m talking about is one of the big divides in the personal finance community – prioritize saving goals or become debt free.
It’s easy to get caught up when reading about those who have summited the debt-free mountaintop and then aspire to the same heights… But I think the problem is that we equate being debt free to being happy – and I’d argue those two factors are independent of each other.
Here’s exactly how we navigate the situation – and where we allocate our “progress money”
We currently have a lot of debt. But we’ve structured our repayment terms such that by paying only the “minimum payments” – at worst case we’ll be debt free (not including our mortgage) in about 7 years. (Read: aggressive repayment plan as a baseline)
We have the option to turn that 7 years into about 3.5 – 6, depending on how crazy we’d like to get… But we’re conceding the extra time to focus on saving money instead.
A few reasons:
1- We have more exposure and responsibilities now
Our emergency fund doesn’t just encompass 2 young adults with their vehicles and an apartment. We have the mortgage, the business, children, cars, and some debt on most of those. A serious financial problem for us could total in the 5-figures pretty quickly, so we need a bigger cushion than some others.
2- I’ll sleep better at night knowing we have an extra $25,000 in the bank
Honestly, I feel less stress and anxiety when our savings number is higher than I do when our debt number is lower. A higher savings account balance feels like a 14-point lead in the 4th quarter – most of the time safe…
3- We’re business owners and cash flow is a business’ lifeblood
I don’t want to have to ask the bank for my money back if the need arises. I’ll much prefer to put a portion of our savings into an online savings account, earn close to 2%, and take the hit on not paying off debt (that carries a 5.2% interest rate).
All it would take would be for a few pieces of critical equipment to break or to have a few slow months in a row – and if we didn’t have a savings cushion built up we may need to borrow some money quickly. And when you borrow money quickly, it normally costs a little extra.
It’s a short-term loss for the long-term win. We’re strategically retreating from the battlefield only to capture the chasing army in a trap up the road.
How does this strategy produce victory?
1- Eventually you will have saved enough money
At that point, you can sit comfortably on the stack of cash and either use a chunk of it to pay toward your debts. Or, you could take the extra progress money and start throwing it on debt after your savings goals are met. But either way – you’re now playing with a lead and a cushion.
2- Emergencies matter less
Replacing your roof or a broken water heater isn’t a calming situation, but it’s a little easier to swallow when you have $25,000 sitting in the bank…
3- You have the freedom to choose
This was my accountant’s original point:
At the end of the year, when you’ve saved a significant sum of money, you can still choose to pay off the debts. Or you could max out your retirement account. Or maybe you total your car and need to get a new(er) one… Whatever the case, you have the freedom to choose what you do with your money – and no bank will charge you to make that choice.
Personal finance is personal (if I’ve said it once…). And everyone’s situation is different… But when you’re deciding between saving a little extra versus paying down debt at an aggressive level, you need to seriously consider your specific situation and, more importantly, your exposure and risk level.
How much debt? What are your interest rates? How much money have you saved? Are you contributing to your retirement accounts…? Literally, thousands of questions can be asked to help you make the best decisions – but that’s the point. Ask the questions, get the answers, and make the best call for you.
What are your experiences with saving vs. paying off debts aggressively? Do you agree with my accountant (and me), when we say that saving more is a wise move (depending on the variables)? Or are you a “debt free at all costs” type of person? Let us know in the comments below!
Thanks for reading!
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