Getting Out of Debt vs. Saving: Which should you prioritize?

Posted by FrugalPinoy on Mar 4, 2009 in Debt, Saving | 7 comments

I received this question from Frugal Pinoy reader “vodkacoke” in my email inbox last week:

I really like your style of writing and the topics tackled in your site. Thanks for reinforcing financial literacy to Filipino community. I believe we really need that.

Anyway, my question is do you need to clear all debts first before you start saving or can you do both together?

Since the email address he/she left with me was invalid, I thought it would be good to discuss my answer here. Also, this is an issue I haven’t discussed in the blog yet.

Back to vodkacoke’s question:

Do you need to clear all debts before you start saving, or can you do both together?

It’s complicated to answer this question, as it depends on many things:

• how much savings you already have (if any),
• how much interest you’re paying on your debt,
• the amount you owe,
• how much you can save each month, and
• how secure you are with your source/s of income.

People who aren’t worried about financial emergencies or losing their source of income can benefit from paying off the debt with the highest interest rate first and focus on that until it’s completely paid off. Also, if your debt is also something you can pay off within 1 or 2 months, then there’s no reason for you to put off eliminating it. The point is that you should carefully plan your debt repayments. Here are some handy articles on debt-elimination by other bloggers:

• The Snowball Method
• The Snowflake Method 
• Comparing Debts and Developing a Debt Repayment Plan

Although debt payment should be a financial priority, this doesn’t mean you should neglect to save up for emergencies. Saving is especially important to those who don’t have an emergency fund to cover unexpected expenses. If it’s possible, do both at the same time. Slowly pay off your debt while setting aside some money for your emergency fund.

Whatever method you choose, the important thing is to to avoid incurring additional debt along the way. Getting into more debt, no matter how small, delays your ability to set aside money for your savings. This is why having even at least a small amount of savings is essential, even if you still have debts to pay.

If I were in this position, I’d put my money both in debt repayments and my emergency fund until my emergency fund reaches P10,000. After that, I’d throw all my money into debt repayments until I’m out of debt. I’ll also look for additional income sources so that I can set aside more money each month for debt repayment. Once I’m debt-free, I’ll put my extra money into padding that emergency fund to up to 6 months’ worth of living expenses.

Why P10,000? Well, that depends on your lifestyle, but for me P10,000 is enough for regular emergencies such as medical expenses, auto repairs,urgent home repairs, etc. While it’s true that you won’t be earning much interest on the emergency fund, it’s still better to have at least some cash for emergencies so that you do not resort to incurring more debt.

There’s no cookie-cutter answer for everyone. The balance between debt payments and savings is something you have to figure out for yourself given the conditions listed above.

How about you? What advice would you give vodkacoke and the others out there who are trying to balance debt with savings?

If you’d like to ask a question like vodkacoke did, or send in a guest article for this blog, please click here to contact me.

Photo Credit: Image by Woodsy