Should we use all of our savings ($14,000) to pay down our total debt ($40,000), even if it leaves us with only $1,000?
We currently have two cars, and our combined debt on the two cars is $14,000. We also have $26,000 in student loans. We have $14,000 dollars in savings. Should we pay down our debt with the $14,000 we have in savings? This leaves us with only $1,000 dollars, but we could save the same amount each month to pay down our remaining debt.
Hi! So glad you wrote to us. And nice job in accumulating that much in savings! That takes a lot of discipline. This is a good question – you’ve heard over and over again that it’s best to try and get rid of debt. However, you want to be sure to do it in a smart way that doesn’t hurt you in the long term. In your case, from the data you’ve given me, I’m thinking you are a relatively young married couple (since you are still paying off student loan debt) with no kids. Both of you have jobs, I gather. I’m not sure if the $14K you refer to is all of your savings or if in addition to that money one or both of you have money in the retirement plan (401(k), 403(b), TSP, etc.) at your respective places of work. I’m also not sure of your combined adjusted gross income (your AGI or how much you collectively make in a tax year that you pay tax on) – that makes a difference in if you can contribute to an IRA. Finally, I’m not sure if at the end of each month you have some extra money left (so that you are adding to that $14K) or if you use all of your income. Financial planners recommend that you have 3 to 6 months saved in a liquid account for an emergency fund. In your case, assuming that your monthly expenses are equal to or less than about $4000 per month, your $14k functions as your emergency fund, and it would be best to keep that for a rainy day if you can and work to add more to it to pay off debt and save for retirement.
So here are a couple of scenarios to consider:
1. Your entire saved money is $14K and you use all your income each month with none or little left over – if this is the case, then I would recommend that you not hurry to pay down your debt but instead contribute some of your savings either to IRAs or 401ks if offered at your places of employment. Figure out how you can either spend less each month so that you have some left over to start paying off that debt while continuing to save and not incurring more debt or to contribute to retirement plans and/or savings. If you aren’t able to reduce spending, you could think about one or both of you getting second jobs to bring in more income each month. Then you could follow the recommendations below.
2. For another scenario: If your entire saved money is $14K and you have some surplus income each month, then you could use that extra to pay off debt while keeping the $14K as your emergency fund. In addition to paying off debt (pay off the debt with the highest interest first), you could send the extra to any company retirement plan you have access to, making sure you get any match your company offers. In paying off debt you don’t need to pay it all at one time…you can always pay a little more and you’ll still be chipping away at it!
3. If you have some other money in retirement plans, your saved money is $14K and you have some surplus income each month, then you might use some of the $14K to pay off some of the highest interest debt and then use the extra each month to continue paying off debt til it is gone. This scenario is the nicest, and hopefully as you earn more money, reign in expenses, or add another job, you will get to this point.
These are some ideas – please write back to us with other questions and best wishes to you both!
From a risk perspective, you're depleting savings that would otherwise serve as a buffer in the case of large unexpected expenses which could put you further into debt. You should consider increasing your automatic contribution to your student loans (likely the higher interest rate) every month for roughly 10k. Enough so that you still maintain an "emergency fund". You'll still be able to pay off the debt fairly quickly while maintaining a buffer just in case something unexpected came up.
This decision really comes down to your preference between risk tolerance and the monthly payment burden. It may seem simpler to pay off the debt, but if the interest rates are lower than historic investment returns, the funds would be better used in a risk-diversified portfolio. Additionally, it can help prevent further debt by having an appropriate emergency fund to cover expenses (which can be properly invested to fight inflation).
I think you have done a great job thinking about your options. The interest rate on your debt is likely more than the interest rate you are earning on your savings so that is a good money move assuming two things. 1) You are comfortable with only having $1,000 - you may want to consider leaving a little more in savings to cover any emergencies that may come up. 2) You have the discipline to save the money that is currently going toward debt payments - the tempation may be strong to start spending the money you had earmarked for your savings.
I hope that helps.
Just because the total debt amount from the two vehicles is the same as your savings, it doesn’t mean you should pay those personal loans off first. The determining factor is the interest rate; compare the interest rates from the cars and the student loans. If the interest rates are higher for the cars, by all means, pay those off first. Same reasoning goes to the student loan debt.
Lastly, given the latest headline of social security will go broke, you may want to allocate a portion of the savings to fund your own retirement plan, such as IRAs. You can borrow for your education, but you can’t borrow for the retirement, least from the government as it has a ballooning debt itself and doesn’t know how to manage.
I would suggest the following: 1) If you haven’t fund your IRAs, put $1k apiece for each one of you. 2) Comparing the interest rate and pay down the loans accordingly. 3) Build up your emergency fund along the way. Best!