Drain savings to pay debt?

Neal has lots of money saved for several different reasons. The problem is that he also has a lot of debt. While he has done a good job of saving, Dave walks him through his philosophy, the Baby Steps and explains what he would do in Neal's situation.

QUESTION: Neal and his wife are trying to decide how much of their savings to put toward paying off debt. They have $49,000 set aside in what he calls the family savings account. They also have $30,000 saved for their kids, who are 12 and 15, outside of their 529 for future expenses such as cars and extra college needs. Their debt totals nearly $60,000, and they have a household income of $95,000 a year. Dave has a tough, but solid, answer for him.

ANSWER: Well, what we teach is that Baby Step 1 is to save up $1,000. Baby Step 2 is to pay off all debts except for your home. The third Baby Step is to fully fund an emergency fund of three to six months of expenses. Baby Step 4 is starting to save for other things, so you’ve done this out of order in that sense.

Were you to start our classes and do the things we teach — be on a written budget, carefully managing your money and making it behave, cutting up your credit cards and all that stuff — we would take everything out of your family savings except for $1,000 to throw at this debt. It almost makes you pass out when I say that, but then you’re going to be on a tight budget and finish off this little bit of leftover debt really fast. Then, you’re going to build up your emergency fund.

I would never have a family slush fund. All investments and all savings should be done with some kind of goal in mind. I don’t care what you’re saving for, but slush money without a name on it ends up getting wasted. So you need to say we’re saving for a car, we’re saving for a vacation, or we’re saving for Christmas. But keep it separated so that the couch money doesn’t get confused with the bass boat money. And you certainly never confuse any of that with your emergency fund; that three to six months of expenses is your foundation.

So, all of that to say, I’d put $49,000 on your debt today. I’d seriously consider, too, using some of that kid money to pay off your debt completely. Then I’d build the emergency fund to three to six months of expenses. If you wanted to replenish a little of the kid money later, you could. That’s what I would do if I woke up in your shoes. I’d be debt-free by the end of the day!

 

 

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