Ask me anything #3rd edition
Photo by: star5112
Each week I give the readers of Gather Little by Little a chance to ask me anything. The only real rule is that I can decline to answer. I’ll do my best to answer as many questions as I can though. Have a question you would like answered? Just drop me a line or leave a comment!
I received two questions since last weeks Ask me Anything post. The first questions is from Emily who wrote:
I have a question about the best way to pay-off a very large debt and save money at the same time. My husband just graduated from his doctoral program and is about to start his new job. For the past year and a half we’ve been living-off of a $50,000 loan. After we move for his job, we’ll have barely any money left from this loan, and thus no savings. This is a personal loan from my parents with a low interest rate (around 3%) that we can pretty much pay back how we want.
I’m confused about how we should tackle this debt since it’s so large and the interest rate is so low. Should we pay it in small increments over a period of about 15 years so that we can build savings, save for a down payment on a house, and start a college fund for our kids? Should we devote all of our extra funds toward knocking it out and ignore other saving needs for about 5-7 years? (probably the earliest we could pay it off with our salary) I’d appreciate any thoughts on this!!!!! Thanks!
Emily, the first thing I would recommend that you do is build up a comfortable emergency fund. Since it’s just the two of you, $1000 should be sufficient. Once you have the $1000 safely stored in a separate savings account you need to start tackling your debt. The best way to do this is using a debt snowball. It’s hotly debated on whether you should organize your debts by interest rate (highest first) or by balance (lowest first), but choose which one you feel most comfortable with. Personally, I like paying off the lowest balance first as it gives you that emotional high of knocking out your debt.
While the interest rate on your loan is low, it’s a family loan. Family loans can cause some really ugly situations, so personally I’d tackle that one first. I wouldn’t even consider purchasing a house while you’re paying off your debt. I’d put everything you can towards it, and just get it gone. Look for opportunities to create some extra income and use that money to pay even more on your debt (often called snowflaking).
Our next question is from David who has a very similar question:
Question: Is it better to build up your savings OR pay off dept?
Situation: We have $16,200.00 in savings and a $16,100.00 pay off on our truck.
Monthly payment on truck is $375.00. We have been able to pay off all credit
card dept effective June 15th! YEA!
My thought is: Pay off truck, use $375 per month to rebuild savings.
IF something where to happen before savings was built back up.
We can sell off truck, that we would now OWN in case of emergency
Which would leave us with only house and operational dept, lights, food etc.
once truck was paid off.
My wife’s thought is: Keep paying monthly on the truck. Keep building up
savings as we have been so we have funds in case of emergency. Payoff on truck
is 5 years out.
Note: I am the main bread winner and my job is considered unstable. We have had
several lay-offs with more to come.
Thanks in advance
David, different people are going to give you different answers, but since I am allergic to debt, I’ll always say pay off debt. Whenever you have debt, you’re paying interest. With today’s savings rates, you’re paying more on a loan than you would be earning in a savings account. Debt is also a dark cloud that follows you around, and if anything bad ever happens in your life that debt can cause you a great deal of trouble.
Here is what I would do. I’d sell the truck and use the money to pay cash for a nice inexpensive used car or truck (with gas prices the way they are, a car might be a better option). Take what’s remaining and add it to your savings.
Now, that’s all assuming you aren’t in the hole on your truck, if you are, than again I would sell it, and use your savings money to pay the difference. Then use a reasonable amount of your savings to again buy an inexpensive used car or truck.
I was in a very similar situation, $300.00 per month truck payment. I sold my truck, used the equity to buy a used 2001 Nissan Sentra and took the rest an applied it against my credit card debt.
Since you feel like your job is fairly unstable, you’re going to need that savings just in case you lose your job, so I wouldn’t recommend using it all to pay off your truck. Selling your truck and getting rid of that truck payment (and associated debt) would free up even more money to save even faster.
Readers, what would you suggest Emily and David do? Anyone have alternative advice? Remeber, if you have a questoin you’ed like to ask either about me or about a personal finance situation you may have, just add a comment or drop me a line.