Paying Off Debt & Saving – How Should You Do It?
If you are reading this, I am going to assume you have written out and put a good budget into practice in order to get out of debt. If not, check out our post on budgeting here. Once you have written your budget, you should begin by saving $1000 as quickly as you are able. This is your starter emergency fund. It won’t cover every emergency, but it will save you from a lot, and help keep you from being tempted to go into debt when typical but unexpected life events happen. After you have saved that initial emergency fund, it is time to begin the debt snowball process.
As your debt is paid off, your momentum continues to grow.
The Debt Snowball
There is nothing complicated or groundbreaking about the debt snowball. You simply take whatever surplus is in your budget and throw that entire amount at your lowest debt while paying the minimum payment on all the rest. Once that is paid off you do the same for the next lowest debt, only now you have more money because you have paid off the lowest debt. You simply continue this process until your debt is gone. The only exception being your home mortgage, if you have one. As you pay off each subsequent debt, your surplus payment will grow and speed up the process of paying off all your debt.
This process enables some quick wins in the debt payoff process. It allows you to see real progress and boost your confidence that you are making the right decision. Some people will argue that it makes more sense to pay the debt with the highest interest rate down first. While they are not wrong from a logical and numerical standpoint, debt and personal finance are more involved than just calculating the dollars and cents. Emotions impact how we spend our money. The debt snowball method has proven to be successful time and again. Because of that, it is the one we recommend at The Money Coaches.
Debt Free! Now What?
The debt snowball method will take time. Depending on how much debt you have amassed it may take a few years to accomplish. After it is finished, you will be afforded a whole new lease on life! When complete, you should, at most have a mortgage remaining. So what should you do with all this disposable income that you have worked so hard to free?
Your emergency fund should be easy to get to, but off limits except for emergencies.
Total Emergency Fund
Earlier we talked about your starter emergency fund and getting it to $1000 as quickly as possible. That amount is very helpful and having it available puts you in the minority of people. However, it is not nearly enough to help you should a serious emergency strike. That is where your total emergency fund needs to become your next goal. Since you are now debt free, you should delegate surplus dollars in your budget to your total emergency fund. To consider it fully funded, you should have a total emergency fund capable of covering your expenses for 3-6 months.
Short Term Savings Goals
The next thing you can focus on once you have your total emergency fund complete are any short term financial savings goals. For many, this will mean the down payment on a house or paying cash for a vehicle. Depending on your urgency you can divide your savings equally between long term savings investments and these short term ones or you can devote the majority toward those short term efforts.
If you are saving for a house down payment, aim for 25-30%.
This will help to cover the 20% down payment that will help you avoid private mortgage insurance, moving costs, renovations, closing costs, and any other unexpected fees that might crop up in the home-buying process.
When saving for a vehicle purchase aim to save 100% of the cost.
Let’s face it, you are debt free, why would you go back? If you must take on debt for a vehicle, make sure the loan is a short one and pay it off with tenacity!
A Major Commitment
Admit it, there is a part of you that smirks while reading this post. It is pretty short, easy to understand, and slightly oversimplified. You might find it laughable that in less than 1,000 words we can go from a basic budget to paying cash for a car. This particular post is a quick read, but a long implementation. You are making a major commitment by taking this path. The steps laid out here may take you several years to complete. It will not be easy, but imagine what it would feel like to be completely without debt. How empowering would it be to be free from that slavery to money and a lifestyle you cannot really afford? The steps in this post are simple, but not easy. Anyone can take them, but you have to decide to start and commit to finish..