Hey y’all! Welcome back to Melissa Making Cents.
As a CERTIFIED FINANCIAL PLANNER™ and Financial Advisor in Dallas, Texas, I often get to coach client through various financial topics that come up in daily conversations.
Recently I was asked if a person should still save money if they have large debts, such as student loans, credit cards, or taxes.
My short answer here is yes. The long answer to this is still Heck Yes, but it can get a bit complicated. Let me explain…
Why it is important to have an Emergency Savings Account
I am a HUGE believer in having a hefty emergency fund. I’m talking 9-12 months of your monthly expenses that are available inside a liquid savings account. I’ll pause for a second while everyone comes to after fainting. Why do I say 9-12 months? Because during a recession or hard times, many people had difficulty finding jobs. You may or may not remember the "fun times" we had from the end of 2007-09. Well..let me tell you, when it rains, it pours. Chances are there is going to be a family or household emergency in the midst of unemployment or under-employment. Good Times!
You are not just saving for recessions though. You are also saving in case of an injury or illness. Life isn’t perfect! You don’t follow the shortest distance from point A to B. Life is more of a roller coaster. You need to be prepared so we can zig when life zags. The 9-12 months provides your family with a little stability when extra money is needed, and it gives you a little extra time to make alternative plans.
Is this easy to do? Nope.. But it is very much worth the effort to hit the target. Especially when you feel like you are living in an old country and western song. You know the tune about the man getting fired, his girlfriend leaving, the truck breaking down, splitting his pants, and the dog running away.. Yeah that one. Perhaps if the man in the song had an emergency fund, he could have at least fixed the truck and kept the dog. (Who needs pants anyway?)
Living paycheck to paycheck is exhausting
No doubt you have been told once or twice to pay yourself first. Personally, if I had a penny for every time I heard it in my lifetime, I would have bought an island by now. For the majority of us, the very first thing we do when we get a paycheck is pay bills or go shopping. My mom always referred to us as living paycheck to paycheck growing up. I never understood it, until I was actually living and experiencing it myself. A new job meant shiny new things, and new things became bigger and bigger purchases, but hey, I was making more and more money. This was until emergencies happened and the credit card debt starts piling up. Thus creating a very vicious cycle.
Make it a habit to build savings into your monthly budget
Having money automatically transferred from your paycheck into a savings account will be a game changer. You know it’s there, but it follows the “Out of Sight, Out of Mind” philosophy. Give it a try. Next time you get a raise, have the increase sent directly into savings and watch it grow.
Got it? Great! Now why is this potentially complicated? Well... simply because of the little fact that life isn't perfect. In an ideal world we would all be setting aside 10-20% of our income into savings and retirement. But the cold hard facts are that most of us just can't. We are living paycheck to paycheck, and it's hard to find the extra money to save. So now what? I'm glad you asked... Now it's time to take a good hard look at your monthly budget, and scrub through all of your expenses. You may need to give up the twice weekly nights out with friends, weekly mani/pedis, and lunches at an upscale eatery...or at least come up with cheaper alternatives. I'm not telling you that these types of changes are permanent, but they are necessary while you are penny pinching to pay off debt.
Paying off debt is a guaranteed return on the investment in yourself
There are tons of methods out there to help you pay off debt. It boils down to personal preference. Every method starts with having an accurate list of your debt balances with the associated payments and rates. Decide what makes the most sense to you. Having debt can have a huge emotional impact on your well being. The financial burden can affect your attitude, which can affect your job, your family, your relationship, and which will put even more stress on your mental health. There is light at the end of the debt tunnel though, and you can get there. After all, investing in yourself is the absolute best investment you can make.
What is the financial difference between a Snowball and an Avalanche?
The Snowball debt repayment method is paying off the smallest balances first regardless of the interest rate, and rolling the payments into the next balance. It’s called the snowball method because the payments get bigger and bigger as debt is paid off. By using the chart above we would pay off the Visa, and then the MasterCard..etc The snowball method can be a great victory for your emotions. One of my favorite quotes from Dave Ramsey is, "What I have learned is that personal finance is 20% head knowledge and 80% behavior. You need some quick wins in order to stay pumped enough to get out of debt completely.” Being able to cross off the debt on your list will feel cathartic, so when you get the opportunity… do it with some Oomph!
“AVALANCHE”! In this case you don’t have to run for your life. But your debts might! To create a debt avalanche you will make the minimum payments on all accounts and use any remaining money to pay off the debt with the highest interest rates first. Normally the highest interest rates belong to credit cards. So looking at the chart above we would pay off the MasterCard with the 21.99% interest first, and avalanche the payments down. This method can seem like it’s taking a bit longer because of the interest still accumulating against your payments. Mathematically this method will save you money because you are reducing your monthly payments by knocking out the highest interest rates first. Psychologically it may take longer to see the effects, depending on your balances and extra funds available. I love the thought though of yelling Avalanche when burying a paid off debt under a thick layer of ink as I’m scratching it off my list.
Why you may want to avoid making extra payments to student loans qualifying for the Public Student Loan Forgiveness Program (PSLF)
According to the U.S. Department of Education, Student loan debt is at a record $1.6 trillion and climbing at approximately 3% per year. We have over 44 million Americans with some sort of student loan debt, including federal loans, retirement loans for education, home equity loans and private student loans. The growing trend is to use one of the income based repayment methods available to borrowers. (This creates a whole different set of problems I’ll address at a later date.) If you notice in the chart above, this student has $22,345.56 in a consolidated student loan that is currently qualified for the PSLF program. While the balance and interest rate is higher, making extra payments to this loan may not be worth it. She is 36 payments into the 120 required payments for Loan Forgiveness. For people trying to qualify or maintain status for the Public Student Loan Forgiveness Program (PSLF), sending extra money to your student loans could have little to no effect on your payments. According to the U.S. Department of Education’s website “You cannot receive forgiveness any sooner than 10 years—even if you pay early or extra every month. For PSLF, you must make 120 separate monthly payments—and you can receive credit for only one payment per month, no matter how much you pay. If you consistently pay more than you have to, it will reduce the amount forgiven once you reach the 120 payments necessary.” So in other words, making extra payments while in PSLF is just wasting your hard earned money. I’m sure you can find a better use for it… like in an emergency account!
The link between debt and mental health is eye opening
The link between debt and mental health is undeniable. Too often I see Facebook posts from friends that are suffering from the burden of their finances. I know how it feels.. I’ve been in the trenches and have fought the long hard battle. It downright sucks, and at times you feel like it’s just not going to change. Is there any wonder that debt and suicide seem to go hand in hand. I recently read a heart breaking and eye opening blog about this dark topic. Kara Stevens recently wrote a blog titled, Suicide Over Debt: 4 Things to Remember When Facing Money Trouble, for Centsai.com, that talks about her co-worker that opted for suicide as a way out of his debt burden. I recommend you click on over and give it a read, because chances are you may know someone suffering from the same problem.
Help is on the way, if you want it
Getting out of debt will take time and hard work. Sadly there is no shortcut, but there is help available if you need it! Consumer Credit Counseling is a great source if you are at wits end. A CERTIFIED FINANCIAL PLANNER™, like myself, can also help you create a plan for your financial freedom.
I'm sure you may know others that could benefit from this information! Please pass it on to them! or have them contact me for help!
Until next time... this is Melissa Making Cents!
Melissa Anne Cox
CERTIFIED FINANCIAL PLANNER™ is also a College Funding and Student Loan Advisor in Dallas, Texas.