Signup to receive email updates
Authors
Recent Posts
- Money Smart Week: A Chance to Keep Up with Changing Realities
- Mind Your Money
- How will the Tax Cuts and Jobs Act of 2017 affect you? Inflation Adjustments, IRAs, 529 Plans, ABLE Accounts, Student Loans, & Estate Tax
- Pay Down Debt or Invest My Money?
- Tax Rates: How Will the Tax Cuts and Jobs Act of 2017 Affect You, Part 2
- Utilizing the Library to Keep Costs Down
- Singing the Credit Card Blues
Categories
- Apps
- Author
- Kathy Sweedler
- Karen Chan
- Kimberly Nute-Jones
- Paul McNamara
- Jennifer Hunt
- Guest Authors
- Pam Atkinson
- Sasha Grabenstetter
- Camaya Wallace Bechard
- Banking
- Budgeting
- Credit and Debt
- Credit Report
- Electronic Security/ Identity Theft
- Estate Planning
- Events
- Going Green
- Health Care
- Holiday Spending
- Home Ownership
- How to Choose/Purchase a ...
- Income Taxes
- Insurance
- Investing
- Job Loss
- Kids and Money
- Organizing Finances
- Paying for College
- Reduce Spending
- Retirement Planning
- Saving Money
- Shopping
- U. S. & Global Economy
Links
- SUBSCRIBE to the Plan Well, Retire Well E-Newsletter
- Choosing a Financial Professional
- More for Your Money: Using Your Money Wisely
- Long-Term Care: Talking, Deciding, Taking Action
- Dealing with Clutter
- Reference to specific external websites, products, companies or trade names does not imply endorsement by University of Illinois Extension, nor is discrimination intended against any that are not listed.
Blog Archives
- April 2018 (1)
- March 2018 (3)
- February 2018 (3)
- January 2018 (3)
- December 2017 (2)
- November 2017 (3)
- October 2017 (2)
- September 2017 (4)
- August 2017 (2)
- July 2017 (3)
- June 2017 (3)
- May 2017 (2)
- April 2017 (3)
- March 2017 (2)
- February 2017 (5)
- January 2017 (3)
- December 2016 (4)
- November 2016 (3)
- October 2016 (4)
- September 2016 (2)
- August 2016 (3)
- July 2016 (5)
- June 2016 (2)
- May 2016 (6)
- April 2016 (2)
- March 2016 (3)
- February 2016 (8)
- January 2016 (5)
- December 2015 (3)
- November 2015 (6)
- October 2015 (4)
- September 2015 (3)
- August 2015 (6)
- July 2015 (4)
- June 2015 (5)
- May 2015 (4)
- April 2015 (5)
- March 2015 (5)
- February 2015 (8)
- January 2015 (4)
- December 2014 (4)
- November 2014 (6)
- October 2014 (3)
- September 2014 (4)
- August 2014 (5)
- July 2014 (5)
- June 2014 (5)
- May 2014 (5)
- April 2014 (3)
- March 2014 (4)
- February 2014 (5)
- January 2014 (6)
- December 2013 (5)
- November 2013 (5)
- October 2013 (5)
- September 2013 (5)
- August 2013 (4)
- July 2013 (5)
- June 2013 (4)
- May 2013 (5)
- April 2013 (3)
- March 2013 (5)
- February 2013 (3)
- January 2013 (2)
- December 2012 (3)
- November 2012 (3)
- October 2012 (4)
- September 2012 (3)
- August 2012 (5)
- July 2012 (4)
- June 2012 (5)
- May 2012 (3)
- April 2012 (3)
- March 2012 (4)
- February 2012 (5)
- January 2012 (3)
- December 2011 (5)
- November 2011 (3)
- October 2011 (4)
- September 2011 (4)
- August 2011 (4)
- July 2011 (5)
- June 2011 (3)
- May 2011 (3)
- April 2011 (4)
- March 2011 (5)
- February 2011 (14)
- January 2011 (5)
- December 2010 (4)
- November 2010 (4)
- October 2010 (4)
- September 2010 (2)
- August 2010 (4)
- July 2010 (4)
- June 2010 (4)
- May 2010 (3)
- April 2010 (6)
- March 2010 (5)
- February 2010 (4)
- January 2010 (4)
- December 2009 (2)
- November 2009 (4)
- October 2009 (4)
- September 2009 (3)
- August 2009 (4)
- July 2009 (6)
- June 2009 (4)
- May 2009 (2)
- April 2009 (3)
- March 2009 (3)
- February 2009 (4)
- January 2009 (4)
- December 2008 (4)
- November 2008 (3)
- October 2008 (6)
- September 2008 (5)
- August 2008 (5)
- July 2008 (5)
- June 2008 (4)
- May 2008 (5)
- April 2008 (4)
- March 2008 (4)
- February 2008 (4)
- January 2008 (5)
503 Total Posts
follow our RSS feed

Wednesday, February 2, 2011
What to do first? Pay down debt, build emergency fund, or save for retirement?
We all want to "do the right thing" with our finances, but sometimes it's hard to know what the right thing is. A question recently came to me about a person who has large student loans and credit card debt. She is working in a low wage job, not yet able to find a position in her field. She's living with a friend and has kept current on all her debt payments. She even manages to have just a little extra each month (amazing). Her question is, what's the best thing to do with that money? Put it toward student loans? Pay extra on her credit cards? Start an emergency fund? Or start an IRA and put it toward retirement savings?
Student Loans
Student loans are one of those special debts that never go away, even if you file bankruptcy. There are certain circumstances where some of the debt might be forgiven, but by and large, you're going to pay those loans no matter how long it takes you. So wouldn't it make sense to use any extra money to pay down those obligations? Maybe. But one rule of thumb when deciding which debt to pay down first is, Attack the debt with the highest interest rate first. Her student loans probably have lower interest rates than credit cards. Plus, she may be able to get a tax deduction for student loan interest. So student loans may not be the best use of extra dollars.
Credit Card Debt
Paying off credit card debt is a very good thing to do, especially if you have a high interest rate. But today, there's the possibility of unintended consequences. In the old days (pre-2008), credit limits only went in one direction: UP! Therefore, when you paid down your balance, you had more available credit. If your credit line was your emergency fund, paying down the balance gave you more available credit to tap.
In 2008 and 2009, that changed. Judging by the number of complaints I've read and heard, lots of people saw their credit limits cut. Some said that the reductions in credit limit seemed to be their "reward" for paying down the balance. So, yes, they had less debt after paying extra on the credit card, and they reduced the amount of interest they were paying. But the reduction in their credit limit meant that they had less available credit to draw on in an emergency. Therefore, a person had to choose between paying down debt and building an emergency fund.
It's hard to say how likely credit cards are to reduce credit limits today. I found some recent complaints online, but I did not find any authoritative source talking about current trends or statistics on this. Since cutting credit limits has been a recent pattern and this person's financial situation sounds precarious, caution may be in order.
Emergency Fund
I would vote for building a small emergency fund first, rather than putting every available dollar toward the credit card balance. She might split her extra dollars between the two goals. It's a trade-off between paying more in interest now and the security of having some liquid (accessible) funds. Once she has at least a small emergency fund, any extra cash could go entirely toward paying down the credit card debt.
There are several acceptable options for where to keep an emergency fund. I discussed these in a June 2008 post.
Retirement Savings
The standard recommendation is to pay down debt - especially high interest debt - before putting money away for retirement. That assumes that the person will actually pay down the debt, and not just charge up the credit cards again. I once encouraged a friend to sign up for his retirement plan at work even though he had credit card debt. I knew him pretty well, and I did not believe that he would ever pay off the credit card. As a result, he might never save any money toward retirement if we followed the standard advice.
Fifteen years later, he still had credit card debt. But he also had a substantial amount in his retirement account.
If this woman is disciplined and serious about paying down her debt, the standard advice might work for her. Once her credit card debt is paid off, she can decide whether to devote that amount each month toward student loan debt or to retirement savings. Things that could tip the balance would include the interest rate on the student loans, whether her employer offers matching on her retirement contributions, whether she has any income tax liability and, if so, whether she qualifies for the Saver's Credit. If she owes no tax for the year, she gets no benefit from the Saver's Credit or from contributing to a traditional (tax-deferred) retirement account.
She might consider a Roth IRA. Her contributions are are not deductible, but qualified earnings will be distributed tax-free. She could actually take out her contributions at any time without tax or penalty, allowing the account to function as a last-ditch emergency fund.
Using her extra dollars for any of these choices will be a good thing. By evaluating her choices, she may be able to get a little more bang for her buck.
What would you do? Click on my name below, and send me your thoughts. We'll feature your ideas and comments in a future blog post.
Related posts: