The tone and content at Get Rich Slowly have shifted a lot in the past five years. When I started this site, I was a financial novice. I was learning about smart money management. Now, I’m in what I call the third stage of personal finance, and the basics come naturally. (Most of the time, anyhow.)
I’m glad that GRS has evolved with me. At the same time, though, I sometimes forget to focus on the fundamentals. April is Financial Literacy Month in the U.S., and I plan to spend a few weeks reviewing the basics at that time. Meanwhile, though, Ilya wrote with a question I’d like to address now:
I started working full time about six months ago, which means that now my student loans (over $20,000) have gone into repayment. Plus I had to get a new car (not actually ‘new’, but new to me), so I took out a loan — partly through my credit union, and the rest from my other accounts and money borrowed from my mother (who kindly does not charge interest).
I’m on a ten-year plan to pay off my student loan, and a four-year plan for my car loan. The car loan is about $5000. The money I borrowed from my mom isn’t a huge priority, though I’m sure she’d like it repaid sooner rather than later. But she won’t be upset if I can’t pay for a little bit. None of my loans have early repayment penalties.
My basic fixed expenses, with some allotment for going out and having a little fun every so often, allow me to save a few hundred dollars each month (this is after a 5% contribution to my 403b).
I have about $2000 in my basic online savings account and another $3000 in my 403(b). (Part of that I can’t touch because I’m not fully vested for another six months.) That’s not a huge amount, but it’s enough to get me through a rough patch. That’s why I’m not sure if it’s better to increase that savings or to decrease my debt (or some combination of both).
My question is this: Is it wise to use my surplus to pay down my loans faster? Or should I just put it in my savings account?
I receive some variation of Ilya’s question every week — and sometimes more often than that. It’s tough to know whether it’s best to save or to pay down debt. There are a lot of variables involved. Let’s walk through some general guidelines have worked for a lot of people — including me.
Laying a foundation
Most experts suggest that before you begin paying off your debt, you establish some sort of emergency fund to act as a buffer against the unexpected. It can be frustrating to be chipping away at your debt only to suffer a series of minor setbacks — car repairs, unexpected medical costs, and so on. With a “starter” emergency fund, you’re able to deflect small problems while focusing on debt.
Ilya has $2000 saved for emergencies already. This sounds like a perfect number.
The next step is to tackle the debt in earnest. For most people, that means credit-card debt. It sounds like Ilya is smart enough not to have a credit-card problem, so that’s a point in his favor. What he needs to do — and I think this is where he’s at right now — is decide what order to repay his debts. He should pay the minimum balance on all of them, and throw everything he can at the one he considers the highest priority. (That might be the debt with the highest interest rate, or the debt with the lowest balance, or the debt with the biggest psychological burden. It’s up to him.)
Once that first debt is defeated, he can move on to the next one. And so on. Eventually — meaning: in several years — he’ll have repaid all of his debt.
While this is going on, he should maintain that emergency fund at $2000 — or whatever balance keeps his mind at ease. When all of his debt is repaid, he should boost the balance in his savings account so that it can cover several months of expenses. (Nobody agrees on what this number should actually be; it’s whatever makes sense for Ilya.)
Once that’s finished, Ilya can begin saving for other priorities.
After reading and writing about money for five years, this is the process I’ve seen be most successful for folks wanting to lay a solid financial foundation. It’s what I consider the first stage of personal finance.
Specific steps
To summarize: If I were in Ilya’s situation, I’d do the following:
- Continue contributing to the 403(b). If he has a surplus every month even after 5% contributions, I think it’s smart to continue that habit. It’ll pay off in the long run.
- Build the emergency fund to the point where he can sleep at night. For me, the $2000 he has now is plenty. That’s enough to cover most minor emergencies.
- Pay off mom. Lending money to family and friends can jeopardize the relationship. And borrowing is simply the other side of lending. I know Ilya’s mother isn’t charging interest, but I’d still pay this off before anything else.
- Repay the car loan. The car loan probably has higher interest than the student loans, which makes it the mathematically smart choice. Plus, it has a smaller balance, which makes it the next logical option when using the debt snowball method.
- Attack the student loans.
- Once the debt is gone, boost that emergency fund from $2000 to whatever feels comfortable. For Ilya, that might be $5000 or it might be $20,000. He’ll have to make that call.
After all that’s finished, Ilya can boost his savings rate to get a jump-start on retirement and to set aside money for things that are important to him, whether that’s travel, entertainment, or maybe a new house.
Finally, I want to point out that although there are some best practices involved, there’s not actually one right answer to this question. Everyone’s situation is different. Ultimately, Ilya has to do what is right for his circumstances and his mindset.
What general advice do you have for folks choosing between saving and debt reduction? And what specific advice do you have for Ilya’s situation? Should he add more to his savings before tackling the debt? And which debt should he tackle first?
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I think you answered the question perfectly J.D. A savings of $2,000 is perfect for a temporary savings account.
IIya, if you are serious about paying down your debt, and you want to do it fast, then keep your savings account around that $2,000 mark.
With any extra cashflow that comes in each month, make sure to aggresively pay down your highest interest, lowest loan, first. Once that is paid off, contribute your typical payment to the next loan.
Yes, your mom will most likely be paid last since she isn’t charging you interest, but if you follow these steps (also known as the debt snowball), then she should get paid relatively soon anyway.
My wife and I paid off $18,000 in 14 months by using this system I explained above. It really works! Just stick to it and watch your debt melt away.
After your debt is paid, make sure to beef up your emergency fund. It should really be over $10,000 to cover at least 6 months of expenses.
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JD–
As a relatively new reader (since Dec/Jan based on a link from Manisha Thakor) I have appreciated all your posts. When I wanted to read about a topic you weren’t covering that day, I poked around the site and read older content– all of which has been extremely helpful to me. Between your site and the book Your Money or Your Life, I have made several changes that are allowing me to improve my financial situation.
I am working on building an emergency fund and paying down debt simultaneously. Most advice says to do one thing at a time, but so far this has worked for me. I just can’t not pay down the debt and its extremely rewarding to me to see the numbers go down. I’ll be out of all debt no later than the end of 2012 and have an emergency fund of three months expenses by the end of 2011.
Many thanks for sharing all of your experiences!
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“Ilya” .. “she”? Uhh.. Ilya is a guy’s name. Um, duh. Doesn’t really surprise me that JD gets this wrong. Even with his trips to Africa, and his proposed trips to Cambodia & Argentina, JD is just another unsophisticated American guy who knows nothing about life beyond the backwoods of Oregon. Burning fuel to transport some blogger around the planet, when digital archaeologists find this forgotten blog in five or ten years, they will be scratching their heads wondering what the planet was thinking, sending a blogger over the whole planet who can’t even be bothered to get genders of names right. Better save that fuel for somebody who actually cares about the world.
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Just a note that Ilya may want to look more closely at the options in her 403b before committing more funds there. As we are finding right now with my wife’s 403b, they often come laden with obscene fees (even more so than you might find in a 401k).
Since she mentions vesting that means she’s at least getting a ‘free’ return on the money, but it’s worth running the numbers to see whether this overcomes withdrawal fees, annual fees, etc. It may turn out that another retirement vehicle (Roth/normal IRA) is the way to go.
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Ilya is actually a men’s name!
I have to say I’m with Liz Weston on the $0 emergency fund. Paying off debts would definitely be my priority. It would be
Much more reassuring psychologically than having some money just sit there while continuing to pay more and more interest on debts.
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I agree with paying off debt first versus saving. However, I disagree with an emergency fund.
I know this is a very stuck-up/spoiled thing to say, but as someone that just began working, I think your “emergency fund” can be your parents. I know once you start working you become autonomous, but you’re still 22/23 and I don’t see why you need to fly SO FAR away from the nest in the near-term.
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@ Money Maker – Troll much?
I think that the advice here regarding the actual question is spot on. Ilya has a decent starter emergency fund and I would prioritize debt repayment at this point. If circumstances change (a raise or, alternatively, a concern about the stability of your job) you can switch to padding the emergency fund a bit if you need to.
Best of luck!
I had to edit to add this:
@ Larry – the point of an emergency fund is to become independent. I knew when I was first out of school that if I really needed them that my parents would help me. But that should not be the default first back up plan. I know my parents would have helped me just as I would help my kids if they need it. But parents have goals of their own beyond being their kids emergency fund and it isn’t fair of kids to expect their parents to continue to fill that role after they are out on their own.
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I went investing (401(K) match baby, ESPP), savings (funded by ESPP) and then debt but that’s more of what’s right for us.
My wife’s a contractor and had some bouts of depression that’s required us to think stability over all else. She just started a full time gig for the first time in a couple of years as a permanent employee so I’ve decided now’s a time we can spend down our emergency fund a bit to go after the debt.
We’re far under water on our mortgage with an 80/20, so we’ve decided to stop funding the ESPP (because they changed extended the holding period to 1 yr) and invest in paying down our highest rate debt in less 2 yrs barring any setbacks, we’ll still have enough emergency funds to cover a prolonged employment dip.
Not to mention, several of my peers have been leaving their jobs recently to accept 20-40% raises, so, increasing my income in the next year will be on the slate. I think we reasonably could have income north of $130k and debt/tax/insurance obligations of less than $1k a month in about 3yrs time.
I understand the debt snowball but and the psychology of it all, but ROI and stability are to me the two most important factors.
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I”m so glad you recommended that mom be paid back before any loans. Just because mom isn’t charging interest doesn’t mean she’s any less of a priority.
$2000 is a good start to an emergency fund, but I wouldn’t stop saving altogether. My biggest regret was not saving more when I was paying down debt. I paid off my debt faster, but at the end I felt like I had to start all over again and build up my savings. Save anything: 10%, 5%, 1%, just keep saving. Once you stop, it’s a hard habit to get back into. If your debt really starts to bug you, you can always take a chunk out of savings and pay it down. But once you’ve sent that money to debt, you can’t undo that decision.
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“It makes no sense to have a stash of cash sitting in a savings account earning 5% interest when you’re incurring three times that amount on credit card and other debt. A lot of people don’t make the connection that increasing income (in a savings account) and decreasing expenses (on your debt repayments) are the same thing. They get stuck in what behavioural economists call “framing” (viewing the same thing differently just because it happens to be phrased a little odd)… Ultimately, it comes down to numbers. If the debt rate is higher than the savings rate, put the money in the debt. If the savings rate is higher than the debt rate, put the money in the savings. Go where the numbers lead you.” – from The Beauty of Debt
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@Leslie – I agree with you that becoming independent is a priority and an emergency fund is a great way to start, but when it comes to paying down debt, where you’re getting charged interest that you could otherwise avoid, why not use your emergency savings to reduce principal. I feel that as a young adult, you have a bigger cushion for emergencies because of your parents.
That said, I am a young adult (with debt and limited savings) that did run into an emergency (wisdom tooth surgery costing 1k+). Thankfully I just received my bonus to cover it, but if I didn’t, I felt that I could’ve gone to the Bank of Mommy and Daddy and gotten an interest free loan.
There are different sides to this and I think ultimately it is determined by the maturity of the child. I would have paid back my parents as soon as possible, so maybe that’s why I would not hesitate to ask them (as they should not hesitate to ask me for a loan).
I see your point that having an emergency fund is a step towards independence, but so is paying off your debts. In the end, I feel that paying less interest on your bank loan is better than relying on your parents in cases of emergency only for a few more years.
Also, Money Maker is right…Ilya is totally a guy’s name.
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One of the best mantras from Dave Ramsey is that peronal finance is very much emotional. I think that is one of the reasons his debt snowball works so well, i.e. paying of the smallest debts first. It is great when you are working on your debt plan to kill off a little debt, and then another one, all of a sudden instead of having 5 debts you have 3, etc.
While you might pay a little more in interest I think for most people the snowball method works best.
So, I’m assuming the Mom debt is the smallest one and I would pay that off first, clear that debt and clear any problems with Mom. Then car, then student loan.
I would be putting as much money towards the debt as you can. I would contribute to the retirement plan but I would be focusing all extra money on debt, inclduing bonus, tax return, found money, etc. 10 years is a long time, I’d try to kill the debt in half that time by doubling your debt payments, from a couple hundred to $500 a month.
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well, you already have a snarky troll telling you that Ilya is a guy’s name. It’s the Russian version of “Elijah”. You’re in good company, however, as the Obamas messed this up too (Sasha is also a boy’s name).
The advice is fine, except symbolically it might be nice for Ilya to make a point of paying back his mom firstshe probably doesn’t expect that, but he would be building some good social capital.
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When I owed my mom a substantial amount of money (did not have first month’s rent and last month’s deposit etc. and wasn’t going to get paid until after I’d lived in the city a month), I did not have any fun. I still would not choose to have fun if I owed a person money at 0% interest. I would feel dirty. Paying that back would be my number 1 priority after staying out of double-digit CC debt. (Especially since mom can probably be relied upon again as a back-up emergency fund if she isn’t abused.)
Then, for me, since I don’t have any kind of behavioral problems, I would save about one month base expenses in savings. This amount would allow me to pay the rent on time if there was a snafu with my paycheck some month. Then I would start attacking the debt ruthlesslessy from highest interest rate to largest, allowing some fun after I’d paid off all “high interest” debt. I consider high interest anything over say, 6%, but your number may vary.
For someone with behavioral problems, I would totally recommend the Dave Ramsey approach. $1K emergency fund, then attack those loans starting with mom, then by size of loan. And lots of rice and beans.
I’ve known both male and female Ilyas. (Also both male and female Sashas. And Ashleys…)
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I agree with JD and dissagree with @LifeAndMyFinances about paying mom first.
Mathematically, it makes sense to pay the interest-charging loans first, but it will certainly strain the relationship whether mom says anything about it or not.
Your relationship with a loved one is more valuable than a few dollars of interest. It’s also probably a smaller amount than the car loan, and therefore fits the debt snowball method better too.
If it takes you an extra few months to pay off the final student loan, it’s worth it. If you do it the other way, it will take years before you even start paying back mom.
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@ Larry — good point about maturity. When I graduated, I split the difference between paying off my student loan (my only debt) and building an emergency fund. (I was saving for retirement too). Perhaps the bank has made some extra money as a result, but I did what made me feel comfortable.
True, Ilya is a male name, but people don’t have to be nasty about it. The thing about trolls is that they always make themselves look worse than anyone else.
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“She should pay the minimum balance on all of them, and throw everything she can at the one she considers the highest priority.”
I think this is right, but I would add that if, for whatever reason, Ilya decides that the loan from Mom is not the highest priority, she should pick a monthly minimum payment to make on that loan also.
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@Money Maker: Sir, your ideas intrigue me, and I wish to subscribe to your newsletter.
@Everyone else:
Yes. We go by the ‘pay yourself first plan.’ 10% off the top into savings, 5% into allowance, folding money, whatever you want to call it, and the rest into debts and operating expenses. How you strategize your debt payoff is entirely up to you. Whatever you find works.
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I would go strictly Dave Ramsey here. Baby Step 0: buy a copy of the “Total Money Makeover”. JD has given you the gist but you should still read it and re-read it. Refer to it often for motivation.
Leave 1,000 in savings and start the debt snowball. Repay the $ to mom first.
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Larry – I agree with your point that a lot of it depends on the maturity of the young adult in question. And…I have absolutely no issue with parents helping out a child when there is a true emergency (your wisdom tooth surgery falls into that category, in my opinion). I guess my issue is using the “Bank of Mom & Dad” as your only emergency fund. Can they be your back up while you get set up? Sure…if the parents are ok with that (not all of them are in a position to be the financial safety net or even if they are they don’t want to be). But I think that we can easily agree here that the point is to get the loans paid off and your own emergency fund in place so that this is a temporary plan.
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I don’t think there’s enough data to judge whether the $2,000 is an adequate emergency fund. We’d have to know what her monthly fixed expenses are. The CFP(R) standard is basically 3 months of monthly expenses (fixed and variable but not discretionary) IF you have some other source of income (i.e.,spouse, trust fund, 2nd job)or 6 months if it’s just lil’ ole you. If Ilya could move back in with mom instantly, she can probably cut rent and utilities from that figure. Also, it depends on how easy it would be to get a new job in the specific industry s/he’s in. The “right” amount of emergency fund isn’t an easy answer. Without that emergency fund, repaying everything else could easily go awry with even a brief job loss. Cash in the bank is still, and always will be, king.
The idea of using the credit card as an emergency fund is crazy–that’s how people go bankrupt in a medical crisis. And you usually can’t pay the mortgage or rent with it.
So, I’d concentrate on having an adequate emergency fund first. Then, how bad does mom need the money? If mom needs it or isn’t fairly wealthy, I’d pay her off first, both for honor and because family counts more than a faceless auto loan company. If mom has plenty, I’d do the Dave Ramsey thing.
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I think JD’s advice here is pretty much spot on. The only place I might personally deviate is that once Mom and car loan are paid off, I would then start actively saving while working on the student loans.
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“The money I borrowed from my mom isn’t a huge priority”
That is exactly the reason why you dont lend your family and friends money. If you really want to give money to friends and family, give it as a gift and never expect it back.
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I agree with @Panda. Currently Ilya is on a 10 year plan to get eliminate her student loans and even though that can probably be chipped down a few years with (assuming) raises, etc that is a long time to hold off on building cash savings and/or saving for retirement. A mixture of both where after paying off smaller loans the money dedicated to those loans be split 75/25 to student loan/savings.
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Folks: I goofed up Ilya’s gender. I completely assumed the name was female. My bad, and I apologize. I’ll change the gender references in the post, but the first 25 or so comments will have mistaken gender references.
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My mother has actually expressly forbade me from paying her back too quickly. Not saying I should not pay her at all for the time being, but she would rather more of that extra money go towards the loans than to her. My plan, for now, is to take a bit of that extra money every month and place it in savings. then every few months write out a check.
2K in savings is even hard for me to deal with. It was 5K but I payed off my smallest (highest interest) loan in one shot just after I started working. I think I just have to mentally accept that 2K is sufficient, which is proving more difficult than I’d prefer. Using a credit card as an emergency fund? I can’t even imagine.
And yes, I’m a guy. It happens…
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JD I’m so glad you placed Mom as a priority in repaying the debt. I was going to make a comment to Ilya along the same lines but now I don’t have to! So often, kids take the attitude that ‘Mom won’t mind’ or ‘Mom doesn’t expect to be repaid any time soon’. You are absolutely correct in stating that relationships suffer to some greater or lesser extent when the parent begins to feel insignificant when it comes to repaying any money that was borrowed from them by the kids.
To my own children: I already raised you guys and made huge sacrifices for you, the like of which you’ll never know! If I lend you money, please regard that loan as one that is important and one that must be repaid in a timely manner. You make my generosity feel insignificant when you disregard the impact that making the loan has/had on my own finances. Don’t take me for granted because it will diminish our relationship. Unless I specifically tell you that the money is a gift, it’s NOT. Be an adult and pay your debts please.
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I have read and followed both Suze Orman and now Dave Ramsey. As Sam stated, I agree with Dave Ramsey’s view that personal finance is very much emotional. We are still working our debt snowball, while saving $100 a month to add to our existing $1000 baby emergency fund and contributing $100 ($50 each) to our IRAs. We will increase our IRA contribution and our savings once we finish our debt repayment.
I agree with JD’s advice to Ilya and would definitely make paying Mom off a higher priority. I did have to ask Dad for money occasionally at your Ilya’s age, but did not like the way I felt having to ask.
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I agree with JD’s advice, but I would add one thing – I’d talk to my parents about how they wanted me to pay them back. This is what I’d advise Ilya to do:
* Explain to mom where he is now financially (e.g. saving for retirement, small but sufficient emergency fund, what loans there are, how much money is available on average each month to pay them)
* Explain how much money that leaves per month after minimum payments.
* Ask mom where in the priority list she wants to be.
I say this because there are a lot of options for mom here:
* This could be *her* retirement money, or she could be going short, in which case Ilya should prioritise paying her back.
* She could want him to pay a little each month, but with the rest going to paying down other loans
* She may not *want* to be paid back while Ilya has other loans with interest on, if she is financially comfortable. In this case, I would suggest keeping her apprised of the state of his finances on a regular basis.
Communication is the key to not souring a relationship like this. Talking up-front and keeping in touch can make it work.
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If you have a match-retirement plan, then max out the match FIRST, then debt, then savings.
People get so hung up on the whole “but the interest rate from the debt” thing. But factually, if you run the numbers, people who start saving for retirement earlier, will FAR outstrip the short term cost of that debt interest.
I only wish I’d been shown how the numbers work when I was 25, instead of waiting. If you invest $5k at age 25 and assume an average 3% rate, you’ll wind up with around $20k at age 65. If you put that off until age 30, you’ll only have $16k at age 65. If you put it off until 35, you’ll only have $14k at age 65. Now multiply that by how much you’ll have if you max out your retirement contributions every year starting at age 25.
Is the interest on your student loan over 8-ish years REALLY more than the money you stand to gain in retirement benefits?
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My jobs retirement plan works as such. For me to be enrolled in the plan I HAVE to put in 5%, obviously I can put in more. They put in 8%, regardless of what I put in.
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@Ilya (#26)
If your mother has actually said not to pay her off too quickly, that’s a different thing. It sounds like you have good lines of communication. As long as you keep those open, I think you’re in good shape. Be sensitive to what she needs. And rock on for having such an awesome mom!
Did having a $5000 emergency fund make you feel better than having a $2000 emergency fund? I ask because some people never feel safe. And if you’re just going to save that $5000 to tap to pay debt, you might as well use it to pay debt from the start. Does that make sense?
In any event, I think you’re off to a good start. I forgot to mention that in the post, but you seem to be making sensible decisions, for which you deserve recognition.
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I agree with JD’s advice. Also, not all the gender references are changed. They jump back and forth.
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I think JD’s advice is pretty much spot on.
The only thing I’d change is to pay off the car loan first then pay your mom.
$2,000 emergency fund is good enough for most younger people. When you get older and have more responsibilities (spouse, kids, house) then you’ll need to increase the e fund.
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@JD – I am afraid I am in the Liz Weston camp. If you’re carrying toxic debt around with double digit interest, you don’t have an “emergency fund” with $2,000 sitting in a 1.5% earning ING account. It’s a false economy and logically makes no sense to keep. If an emergency of $2000 comes up 5 months down the road and you pay it off with the emergency fund, you’re in a worse position financially than if you paid $2000 worth of high interest credit card debt off with the $2000 then charged the $2000 to your card. With the new cc rules that $2000 emergency charge would not accrue interest for a month either, even with a balance rolling forward.
It’s simple math, and quite logical. I can’t agree with doing something illogical and stupid because people can’t add and multiply.
Also, if the emergency never comes, or comes down the road, you’re in a *much* better position. If an emergency fund must come before paying off toxic debt to bring some sort of nebulous “comfort” factor, at least recommend a token savings of $250 or something just to say “I can save something”.
In this case for Ilya, I didn’t see the interest rates charged on the car or student loan, but assume student loan is lower interest than the car loan.
In his shoes I would ignore the student loans fast repayment and just pay the minimum on them at first, drain his e-fund to pay back mother in full ASAP, and tackle the car loan with viciouosness all while contributing enough to get the full match from my company retirement plan.
The most valuable thing he has is his family relationship, and personally I would not feel good about owing any family member large sums of money used to buy a car. That would be first.
Good luck Ilya!
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Thanks J.D. Debt and money related stress are kind of a big deal in my family, and so my mom taught me early on to be responsible with the money I make. She is in a very comfortable situation, and would rather I find myself in that same situation faster. Direct quote “The extra few hundred dollars will make more of a difference to you than to me, just don’t spend it on alcohol”
And I suppose you bring up a good point, if I’m only going to save money to then pay of large chunks at a time, it makes sense to just start of paying down directly.
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Even before Ilya checked back in, I’d have said not to listen to commenters on a message board, but rather to your mother! Now that we know that mom said NOT to prioritize it, I’m with that. If you want to send a small amount as a token, that would be fine, but do what your mother tells you!
As a parent, I’d much prefer that my children pay off interest-accruing debts than paying me. If I didn’t have the money to give, I wouldn’t give it. If I needed it back in a specific timeframe, I’d specify it and we’d sign on it. If I wanted the child to pay other things first, I’d say that, just like his mom did.
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One last gender reference:
“For me, the $2000 she has now is plenty.”
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We keep an unusually large emergency fund. Only one of us works because we move every year to a new part of the country (and sometimes world!). Moving costs (while reimbursed afterwards) are sometimes substantial, so we have to have money for 1st, last, deposit, plus moving costs, hotel costs while we wait for our crap to show up, etc. In addition, we have significant student loan debt (we are snowballing as we speak). While some financial advisors would advocate to use that “excess” emergency fund to pay down debt, we would do nothing but worry at night about our next move. We have about 7 months of average monthly expenses (expenses are different in every place we live), but a few years worth of income in student loan debt. I work part time at each place we visit, and that often goes towards rebuilding our emergency fund or paying for travel home to see our families once every other year. I am an advocate of having an emergency fund that lets you sleep at night, then worry about debt repayment. As JD has often pointed out, personal finance is less about math and money than it is psychological forces. Keep your brain happy, and it should keep your wallet happy (as long as you are not shopaholic!). LOL.
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Here’s my take on it. I think the method often recommended of paying off smaller debts so you only have a few or paying off a debt that you’re emotionally tied to might be good advice for those who have trouble with money-management, but Ilya doesn’t seem like that type. I don’t know how secure you job is, Ilya, or what emergency expenses might come up (is the car a Honda or a GM and how old?). But I’d put all but $1000 onto the highest-interest debt immediately, pay off the highest-interest debts first and work my way down to the lowest without increasing my savings (other than any required to get those contributions from your employer). Oh, and I don’t know if student loans are a tax deduction in the US. If so, that might change the numbers slightly (you’d have to crunch the numbers).
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Thanks for publishing this, J.D. My situation was extremely similar to Ilya’s when I started working, except I had significantly more in student loans (I am very, very nearly done with my loans). Partly because of the huge amount of the loans (undergrad & grad school), I have thrown all of my money at my small car loan (highest interest rate) followed by my loans in order of next highest interest rate.
Once I got to loans below 6% interest, I took a break from the aggressive loan payments and “rewarded” myself by opening and funding a Roth IRA. Then I went right back to my loans, trying to also build up an emergency fund at the same time. I have read articles where people said it would be foolish to pay off low-interest debt instead of funding retirement, but when you look at the interest you are accruing on the debt, even low interest debt adds up. Plus, as I see it, investments are never a guarantee, whereas paying off debt is.
This is what has worked for me, but I’ve also realized that this is a very personal choice, and not everyone would do what I did, or in the order I did it. As long as you are being careful with your spending, aggressive with your goals, and keeping a balance with your goals, you are going to be just fine. Good luck, Ilya!
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Job security wise I am very secure. I work for the university I graduated from in a research lab. It’s a state job, so baring massive layoffs across the board (which at a state university is unlikely [even if in other depts. it might be necessary]) I am fairly safe.
I am in a new stage of my life (i.e. the real world) so what emergencies I might encounter are yet unknown. The car (’07 Subaru) is new enough that I should not need to be under the hood fixing it like my old one every weekend. So i’d like to keep more in the e-fund than $1000, just peace of mind for me.
Also, my student loan is at 6.1% and the car loan is 5%. So the smaller loan also has the smaller interest rate in this case.
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Don’t worry about the mixed up gender references! Evelyn Waugh’s first wife was also named Evelyn. Imagine the problems that caused–
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I would keep the whole approached balanced and save while paying off debt. I don’t think it is a good idea to stop saving completely. An emergency fund and other savings is vital to your future financial health just like paying off debt. I would suggest doing a 60-40 split, using the majority towards your debt. An all or nothing approach almost always doesn’t work out.
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How does your Mother feel when you are going on trips yet you owe her money?
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The current focus is on paying down the loans and getting out of debt — definitely the right thing to do.
I want to encourage you to spend a few minutes looking at your403(b) and making sure you have invested wisely to make the most of those investments. Be as diversified as possible as that can make a significant amount of difference to the total amount at the end.
Those of us with grey hair can attest to the fact that the years fly by and an additional 3% earned by smart asset allocation choices over a career more than doubles the amount of retirement money.
You may not care now, but you will care later!
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Pay mom first.
Selfish reason: The faster you pay mom back, the more willing she will be to bail you out in the future or help with bigger purchases.
Less selfish reason (excuse me while I get up on a soapbox here and use my “mom” voice):
She’s your mom. She cares about you. She needs that money or it wouldn’t have been a “loan.” She’s not obligated to lend you money indefinitely because she’s mom and that’s what moms do: sacrifice everything for their children. Grow up. If anything, you owe HER for all she sacrificed to raise you. Should you pay off a faceless corporation that gets bailed out with tax money and doesn’t give a crap about you and makes a living screwing people over, or should you pay off your mom, who clipped coupons, meticulously balanced the checkbook, took you school shopping every year and might not have a lot of retirement savings so that you could live in a nice neighborhood, eat nutritious meals, take dance lessons, and have vacations and opportunities that she never had? Why do you have to ask?
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J.D.,
Great advice! I love the column, keep up the good work.
Ilya,
I wouldn’t be too confident with a state job right now. Most state budgets are in terrible shape and higher education is one of the easier things for states to cut to balance the budget.
Other posters,
I don’t know how you would recommend not having an emergency fund and using a credit card as an emergency fund. On the math side if there is a $2,000 emergency and you put that on a credit card with a 15% interest rate that it takes you a year to pay back doesn’t work so well. On the emotional side once you are done with credit cards it is nice to not have a credit card and write a check when the car needs $1,000 in repairs. The last time that happened to us it stunned the repair person that we didn’t need to set up a payment plan or use a credit card.
Here’s to sleeping easy at night. Have a great weekend everyone.
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Jen,
My mom and dad also said they wanted me to pay off other debts first, when I borrowed from them. I guess it depends on what income bracket mom and dad are in, but I saw paying my mom and dad back as a priority immediately below paying rent, making sure my car doesn’t get repossessed, and buying food.
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Your advice was spot on, JD. I particularly liked this bit…
“…he should maintain that emergency fund at $2000 — or whatever balance keeps his mind at ease.”
While I can see the logic of using credit cards, for most people this just continues the cycle of not having control over their money. A basic emergency fund gives you that control so you can make decisions from a position of power instead of fear.
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