Savings vs Debt

www.daveramsey.com

I agree with his philosophy, although many people will disagree. Pay off your debt first! Maybe if you crunched numbers you may find you are better off saving money and maintaining certain types of debt, but numbers are sometimes not as important as peace of mind and the wonderful feeling that comes with being debt free.

Pure economics:  What is the cost of carrying the debt?  What rate-of-return can you safely earn with the cash?  What's the difference?  Here is the important one:  If you deplete your cash to pay down this debt, what would it cost you to incur debt in the future?  (For example, if you have a car loan at 6%, pay it off, but end up taking out a signature loan at 14%, you're probably not better off.) 

Emotionally:  How do you feel about the debt, cash, and your future?  If having this debt leaves you anxious, then consider paying it off.  If this debt is the only thing keeping you going to work every day, what would be the impact of no longer having this driving force?  (Would you quit or slack-off, thereby disrupting your cash-flow?) 

It's crazy to pay off debt where the interest rate is lower than the interest you can earn by not paying the loan back.  Your long term wealth will be lower. I owe 160k in Medical school loans that are 3.75-4%. I pay the minimum. Why? Because I can make at least 7-8% investing surplus. Over 10-20 years that ends up being a lot of money!  Even if I wanted to pay off the medical school debt early it would make sense to invest it myself and earn 8% on it, then pay the loan back out of my earnings.  If the loan is for 8% (I have one second mortgage at this rate), then by all means pay it off. It's doubtful you can make more than 8% on a regular basis.

  This is a LOT different than maxing out your credit cards on crap and having a debt to earnings ratio that is too high.  Certain debts actually save you money over the long haul (mortgasge tax break is one of thelast bastions of tax breaks).

  Every month. I look at my loans that are outstanding and target those that have higher interest. First 401k get paid into (Thrift Savings for me at the VA). All credit cards get paid off, and then any loan that I feel is at an interest that is higher than what I can make investing or in real estate. Whatever is left over goes to investments.

I agree with all the folks above who basically described "good debt vs. bad debt" above... but there is one thing not mentioned above, and that is the concept of an emergency fund.  And I am not talking about the "$1000 for emergencies" described above.

If you don't have at least three months' expenses socked away somewhere safe, like a money-market fund/savings account/CD, you shouldn't be investing anything (with the possible exception of 401k, which is the best thing one can do with their money, IMHO).

I was laid off about a month ago, and although I didn't end up needing all of it, it was comforting to know we had five months cash there.

our strategy after we got married was:

1. pay off credit cards
2. build emergency fund
3. build wealth

I think the thing about having debt, is it puts you in a problematic state.  What happens if you get laid off (not you personally just in general).  If you aren't as rich as you once were, thats ok because you can just get more frugal until you get another job.  If you have debt you MUST have income to pay that payment.   How much more could you invest / spend a month if you have ZERO payments?

...PS bluejack, still looking forward to that giant review  

Why not pay off your student loans and use the money you would be using to make the minimum payments to invest in your 7-8% investments?

For the poster who mentioned Dave Ramsey - my wife and I have gone through his program and it really changed our perspective on money.  All we have now is our mortgage, which we're tearing in to as much as possible.  We have such peace of mine when it comes to our finances now!  It's great to see others have heard of his program.

The only additional thing that I think is a good idea besides holding your debt to good (I don't mind carrying a mortgage), and having money in ready savings, is keeping your living expenses including debt to a level that could be paid by one income in an emergency.  That just really helps take the pressure off, so my vote would be to definitely pay the debt off.  

True, but it has also forced a lot of people into bankruptcy.   It's a gamble, with decent odds, but still a gamble.  

True, but in the scenario I presented, I would have 10,000 in cash to pay my bills for 4-5 months while I looked for work (including the debt payments).   If I had no money and no savings I would be forced to borrow and I have no money to pay the bills in a month when they come due. 

I'm wondering though, and I'm basing this on a true life scenario that I can put myself in right now.  If you have NO debt, then this means you have no mortgage payment.  And you are not making car payments because you have no car debt.  So basically you would have to pay rent, utilities, food and gas.  Of which the rent is the only one really pressing.  You can skate on your utilities to a certain extent, and the food and gas budgets can be cut back on.  It definitely shouldn't take 4-5 months to find a job that could pay those bills if you were a skilled enough worker that you earned enough to pay them before.   I'd still vote for no debt. 

Because you're putting a lot of money into paying off those loans and not putting it into the 7-8% returning investment for that whole time period.  Compound interest really pays off years down the road, so you have exponentially more in the end the sooner you get money into investments with those kinds of returns.

Ok, that logic makes sense.  Good way to put it.