Pay Off Debt or Save for a Goal?
My fiancé and I have been struggling with managing our financial priorities lately. While I am more in favor of eliminating all of our debt as fast as possible, she would rather pay down debt on schedule while pouring the majority of our resources towards a down payment on a house.
Pay Off Debt
We want to eliminate debt so that we have access to our income to build wealth. We are currently paying $900 each month on student loans and car payments combined. That is a lot of money to be sending off to creditors each month. At the very least, we have no credit card debt to speak of. All of our debt is under 6% interest rates.
Save For A Home
We also want to have a home to start a family and be together. A townhouse in our area starts at around $300,000. We have set a goal at around $350,000 to be safe. That would put a down payment of 20% at $70,000. Even at our high income, it would take several years to come up with that amount of money.
Having a home is a significant emotional turning point for us. It means a lot and it is worth the work. When we have a home we will be able to do many of the things we have wanted to do, such as have two cats. And also start a family. Hopefully in that order.
Lets look at the numbers.
Together we save $2,200 each month towards financial goals like our house down payment. This number includes the extra paycheck months as well averaged out over the year. We make $900 in debt payments each month together. That is $3,100 each and every month that we are applying to our goals. Not too shabby.
Our total debt as of the beginning of this month was $38,946. Divide that by $3,100 and we get 12.56. Of course I realize that not every penny would go toward debt pay down. Some of it would cover interest, but we also would have the advantage of a few extra months, we are not going to start a plan of any sorts until after our Wedding in June anyways.
It is reasonable to assume, that with a bit of elbow grease, we could pay off all of our debt within a single calendar year if we applied all of our extra income to the task.
Here is what it would take to raise $70,000 for a house.
| One Year | $70,000 / 12 | $5,833 per month |
| Two Years | $70,000 / 24 | $2,916 per month |
| Three Years | $70,000 / 36 | $1,944 per month |
| Four Years | $70,000 / 48 | $1,458 per month |
At our current level of saving, we would have our $70,000 easily in three years. But we would also still have most of our debt too.
A Hard Decision
If we pay off all of our debt, which we could do in under a year, we would then be able to comfortably save $70,000 in two additional years. Paying down the debt to me makes perfect sense. As Dave would say, we are unlocking our strongest wealth building tool, that being our income. No matter what, I do not see any situation where we would have a home in under three years. Sad to think about but it is the truth.
An important note is that all of these calculations are conservative but also risk prone. It does not include any pay raises that we both expect in the next few years. On the other hand it does not account for the possibility of one of us losing our jobs unexpectedly or a major medical event that could happen to either of us, both, or even one of our family members.
In the best case, we achieve both goals ahead of schedule. The worst case scenario is hard to imagine. If it does happen,then we will have more important things on our minds than saving for a house. Plus, that is what insurance is for.
So what will it be? Save for the house, pay down the debt, or both in moderation? We are more than likely going to be pursuing a dual strategy. We hope to get the best of both worlds without sacrificing too much intensity. Either way, we should be prepared to buy a home in the next three years or so. We are excited just thinking about it.
May 13th, 2008 at 10:10 am
This is a Mike’s fiancé and I would like to put my two cents into this discussion. I disagree with a statement that my future husband made in his post: “My fiancé have been struggling with managing our financial priorities lately”.
This really rubbed me the wrong way. Quite the contrary, my financial priorities are pretty set and there is absolutely no struggle managing them. What I believe Mike means is that my financial priorities differ significantly from his. While we are very much on the same page about living frugally (within reason) and saving for our goals, such as retirement, buying a house, or starting a family, I have a different idea of how we should get there.
For example, I don’t think that we should pour all the extra money each month into debt elimination. In my case, my car is finances for 6.99% and at the current rate of repayment it should be played off in about 1.5 years. At the best case scenario, paying it off early would save me about $600 in interest payment that I would otherwise pay if I stick with the current payment plan. My student loan situation is even more favorable. While the amount of the loan is greater, around $13,000, it is locked in at only 3% interest rate. With the inflation the way it is, it is likely that the balance of that loan will be getting cheaper and cheaper every year since inflation is likely to surpass 3% this year and maybe in the next few years.
Mike’s student loan a bit larger and it was consolidated under a slightly greater interest rate; however it is still a very good deal in today economy. I am not even mentioning Mike’s car, as it’s nearly paid off, and it should be off the books in the few months with the current monthly payments.
I think that we should stick with the current repayment plan since our debt is under very favorable conditions, and instead put the extra savings to the house down payment. While we will not achieve our goal in about 3 year regardless of the way we approach it, the major benefit of my approach would be that we will have the funds to buy a house if a great opportunity presents itself unexpectedly sooner than in 3 year.
As an example, few weeks ago I was looking through the realtor website and came across a very nice starter home for the asking price of $220,000. This price is almost unheard of in this area, but with the current sub-prime mortgage situation it is not surprising that there will be people ready to sell their house for lower than the fair price of the home. With the house at that asking price, a 20% down payment would need to be only $44,000, something we can realistically save in a little over a year and a half.
Unfortunately, this house was located in the adult community, and wasn’t suited for us, however in the case a property comes along for a good price I want to be in the position to buy it.
This about sums up my point of view, and most likely Mike and I will have to come to some kind of compromise that would make both of us happy.
May 14th, 2008 at 5:33 am
Touche my love.
I want to first point out that the original post has a typo that is now fixed. It should have been, “my fiance and I have”. There was no intention to single you out.
That said, there are many other benefits of debt pay down that are not covered such as the security it provides. In the event that either of us loses our jobs in the near future, it would be far easier to survive without $900 in extra bills to pay each month.
There is also the emotional benefit of knowing you are not a slave to to the creditors. Honestly, inflation aside, I would feel better if it were our choice where those $900 went every month.
If personal finance was about nothing but numbers, then people like Dave Ramsey would have been debunked as a fraud long ago.