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The Daily Poverty Post.

talk-amongst-yourselves-discuss

When you are in debt, is the whole Pay Yourself First still applicable?

And by the way, just who is impressed by Bossy’s use of the word applicable? Plus, you should hear her say it. Kind of like a mouth of marbles. Marbles made of peanut butter.

Anyway. This Pay Yourself First issue keeps coming up — on this site and on way better sites that actually know a thing or two about finances.

But on the other hand, Bossy has heard her whole life that credit card balances are the very first thing that should be paid off, and you see where that advice has left Bossy.

Bossy found the following advice in a Consumer Reports article, which is kind of ironic because if we weren’t such consumers we wouldn’t be in this pickle to begin with but anyway: not only does the following suggest paying off debt before paying yourself, but it says to pay off the highest interest loans first, and not those with the smallest balances:

“We’ve said it ourselves, and we mean it: Build your savings automatically by direct-depositing part of your income first into a tax-deferred retirement plan, such as a 401(k), 403(b), or IRA, and then, if you have more to invest, put money into after-tax investments such as a savings account or no-load index fund. Ideally you should put the maximum allowable amount into your tax-deferred investments before moving on to the taxable ones.

But does that suggestion hold if you carry large balances on your credit cards or have other high-interest loans? No. Unless you are making fabulous returns on your savings and investments—higher after taxes than the double-digit costs of your credit-card debt—deal with your debt first.

Focus first on paying off your highest-interest debt. Pay down, say, an extra $500 a month until that account is paid, then move on to the next-highest account until it’s all paid off.”

What do you think?

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Reader Interactions

Comments

  1. what is working for me is Dave Ramsey’s ‘snowball’ effect.
    Pay down small balances and add that payment to next smallest and so on and so on. He suggests having a 1000.00 emergency fund and to concentrate on getting out of debt. When you’re out of debt you can save.

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  2. I’m with Angie. The satisfaction you feel when you pay down a debt can encourage you to pay down even more. That being said, is there any way you can refinance your high interest rates?

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  3. I second Dave Ramsey. It worked for me. I only have a mortgage now. You gain more momentum when you aren’t sending out little bits to alot of people. Also it’s very encouraging to see the names on your debt list shrinking.

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  4. I concur—Do the cc’s first, UNLESS you don’t have a small amt socked away for emergencies.–in that case, do both simultaneously until a little padding is accrued. Then cc it away.

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  5. I agree that you should attempt to get lower rates on everything (which I believe was the subject of a previous poverty party post), and then pay down the highest-COST debts first. Take a look at how much you’re paying in interest each month on each account, and see which ones are costing you the most and pay them first. Well, except for your mortgage, where the interest is actually tax-deductible…

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  7. SSG is goin’ rogue. I’m a firm believer in saving for retirement. Especially if your company matches your 401k contribution. The earlier you start saving, the BETTER. I worry people are putting off saving because they’re dealing with credit card debt for years. My advice is this–put some money away for a blown tire, needing to call a plumber, etc. Cut up your credit cards. Figure out what amount you can afford to pay on them each month. Start with the smaller account first which your other readers referred to above and don’t give it any more thought than that. If you focus on debt too much it tends to increase because you stress yourself out and then want to spend to release some of the stress. Focus instead on the habits that lead you to spend in the first place. But NO judging or beating yourself up!

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  8. I would always save something, anything. Even a little bit will add up in the long run. After you put that little bit aside, then pay the rest of your bills. If something were to happen to you or your husband, at least you’d have a little saved up that could be used before you had to start forking over the credit cards again.

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  11. I tend to think that paying off the smallest debt first works best. The main way it helped me is the whole movtivation thing. It’s like a big gold star, getting one paid off and out of the way.

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  12. I’m spending my savings, not adding to it, but don’t carry card balances either. I have in the past though, and I agree with paying off the high-interest loans first, that worked for me.

    That and doing the balance-transfer thing to the card with the lowest rate. Though I haven’t seen offers for doing that lately — maybe it’s no longer applicable.

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  13. I think the Largest/Smallest First decision needs to be made based on which type of “debt personality” you have.

    If you don’t mind getting harassing phone calls, if you can tolerate the dunning letters, etc, then by all means try the “highest Interest Rate” first method, regardless of the size of the actual debt.

    If you are going to have an ulcer, coronary, or nervous breakdown, then paying off small ones first and larger ones later will probably cut down on the “nagging” from your creditors faster.

    What worked best for me was a bit of a combination of the two (so I only have dispepsia, hypertension and depression) – Take a look at all the bills. Add up how much the interest is for all. Decide how much more you can afford to pay that month. Divide that “more” amount by the number of bills, take THAT number and add it to the interest, for each bill, round the number up to the nearest dollar and pay. (Sewmouse probably lost everyone at “Take a look” – I am not the best at giving instructions)

    So if you have interest payments due for $35.77, $14.00 and $12.33, you will be paying out $62.10 to start. If you can afford a total of $300.00, you figure out that difference ($300 minus $62.10) and get $237.90. Divide that by the 3 bills, and you have $79.30.

    So add $79.30 to each interest amount. Now you have 3 payments of $115.07, $93.30, and $91.63. Round to the next dollar and write 3 checks – $116.00, $94.00 and $92.00.

    Everyone gets SOMETHING, you lower your principal amount so that next month the intrest will be even less (you DID chop up those credit cards, right?) and it may at some point happen that your “add to the interest” amount is more than the principal amount of one or another bill, and you can either apply that difference to all the other bills, or use that to start bulking up your IRA again.

    /encyclopedia

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  14. Oh my word, there is a Dave Ramsey echo reverberating in this post. I am with the other posters, yo. I am working on an emergency fund then will stop saving and throw it all at my debt. That emergency fund keeps you from using your credit. The you take the amount you were saving and do the debt snowball, paying off the smallest balances first. What you were paying on that first balance, take it and apply that to the next so you are paying more on one the next smallest balance…then when it’s paid off, you keep that up instead of saying, “Yay! Debt paid down! More money to spend!” i

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  15. I could see it going either way, really. I’m working on paying off the credit cards and not saving because I simply don’t have the money to do both.

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  18. Wow, Sewmouse, that’s a lot of math but if my sleep deprived brain is grasping it correctly, it makes good sense. I’ll have to run those numbers on my payments for this month to see if that changes my strategy. I’m a lowest-balance first payer-offer. I’m a highly anxious person so I need to see progress and at least trick myself into believing I’m making headway, because I hear that heart-attacks are expensive.

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  19. Consumer Reports is stupid: “Pay down, say, an extra $500 a month until that account is paid, then move on to the next-highest account until it’s all paid off.”?!?!?
    Because if I had an extra 500 bucks to throw at my credit cards every month, I would have used that cash to make the purchases in the first place!

    By the way – Sewmouse? I think you might have been absent from class on the day we learned that Bossy = Math Genius! I used your formula and it doesn’t work for me because being something of a math genius tells me that $137 is less than $178 where $137 equals the interest-plus-extra-payment calculation and $178 equals the MINIMUM payment Chase is demanding.

    Oh and in case anyone out there has a head that has not yet exploded, how do you handle fixed payment loans? Because the balance on my school loans makes me want to go back to bed. For like, a month.

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  20. I say pay yourself first – maybe just a small amount so that you build an emergency fund and don’t go piling on more debt if something happens. Re: CC balances – even though it might make the most sense math-wise to tackle the highest interest rate first, it may be more satisfying and motivating to kill the smallest balance first and be rid of it forever.

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  21. My husband and I go at our finances a little differently than most people we know. We have two credit cards that offer great rewards, and we put EVERYTHING on them (one is for household, the other is for our Ranch). We never, ever use cash unless we absolutely have to, but we pay off both cards EVERY MONTH.

    This works for us because we earn a gazillion credit card reward points which we use to purchase travel, gifts, gift cards, electronics, etc., and if we have no need for any of those, the reward points can be redeemed for cash toward our balance on any given month.

    The credit card companies also send us a quarterly statement that breaks our purchases down into categories so we can see how much we’re spending, where, without me having to plug all that info into microsoft money (because I haven’t updated that since, um, 2004).

    All that being said, I’m totally off topic. So for us the priorities go like this: accessible savings, investments, debt. But if ever we HAVE a debt, we don’t allow ourselves any fun stuff until the debt is paid off.

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  22. don’t forget a simple phone call can also usually get your credit card interest rates WAY down. I know someone that got their 35% interest knocked down to 2% for 6 months…she got it paid off in that 6 months thanks to the lower rate!

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  23. We pay highest interest first. However, if we get to a month where we could remove a debt obligation in one fell swoop, then we’ll do it that month just to feel good.

    We are big on taking on interest free debt for CERTAIN THINGS. I’m talking, completely necessary home improvements, where we’ll take $1000 out on a Home Depot card, knowing we won’t pay interest for 6 months and that it will be paid off before then. We did this to purchase new exterior doors, the old ones had at least an inch gap around them. It cut our monthly electric bill by $25, and we’ll have them paid off well before the interest comes knocking. I would have preferred to save the thousand and paid cash, but that would have been six more months of all the HVAC going out the door. We never take out more than a thousand of this debt at a time, and in this way removed some dangerous paint, replaced a dangerously old washer dryer, and re-built a dangerous deck. Dude. I was living in a dangerous house, it now occurs to me.

    Also a fan of balance transfer to 0% APR for 6 months. Way back when I was an actress and had $10k in credit card debt, this is what I did when I finally faced the music and quit acting and got a job with a regular paycheck. We paid the $10k off in 2 years, on a single income, with 6 figure student loan payments also. It was hard as hell, but felt so good! I consolidated it all, negotiated interest free for the entire 2 year period, divided what I owed by 24 months, and paid that amount come hell or high water. Christmases were scarce, but it was a wonderful gift to myself when I got my 0 balance statement!

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  24. More later, but beware the balance transfer! (beware = be aware!) They used to be “free”. Now, most (nearly all actually) charge a 3% transfer fee. On the entire transferred amount. Not so good…

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  25. Dave Ramsey worked for me!

    You have to have some cash stashed to take care of things that crop up (blown tire, etc) or you’ll just end up putting those emergency expenses on a credit card, which defeats the purpose of trying to pay them off.

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  26. I’m with SSG. If your employer’s 401(k) has matching then contribute mininum to get the matching. IT’S FREE MONEY!!! More than likely you have to be vested in your plan but with most plans I’ve seen that usually happens over 3 – 5 years.

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  28. The Dave Ramsey thing–I gotta admit–makes me want to smack myself in the head. Or someone else.

    There are only two reasons that it makes sense to pay based on smallest debt rather than highest interest. (1) Psychology. And I’m not saying it’s not important, but it’s not finances. (2) If you’re strongly cash constrained. Meaning if you are normally paying barely minimums and you get some extra cash and want to free up expenses in case some day you don’t have enough to cover all the minimums. Then it may be better to pay a higher interest rate on a few cards for awhile and pay off one (hopefully small one) first and then if you are cash poor one month you will have fewer obligations (though still hefty ones that are growing faster).

    Otherwise, if you have steady pool of extra money and are paying down debt, it makes the most sense to pay off the highest interest. In our case, for example, we DO have about $500 extra each month to put toward our daunting debt which we amassed as grad students, selling a house in a bad market, a prolonged adoption and a daughter born while we were poorly (barely) insured grad students. It’s UGLY. But about 1/5 of it is sitting in 2 small loans from family at 0% interest. a touch more is on a card at 3%, another chunk is on another card at 6%, and the rest of the beast is on a card at 19% thanks to a recently ended promotional rate. According to the DR plan we’d pay off the totally free debt first (!!) while the rest sat around earning interest. Then we’d tinker away for a few months at that 3% loan. Meanwhile every $100 we take off of THAT debt would be worth 6 times the savings in interest if we had paid off the other debt. DOES NOT COMPUTE.

    Ok, huge personal complaint about the Dave Ramsey plan. Sorry. Go that route if it’s psychologically motivating to you (because, frankly, better paid off inefficiently than not paid off at all!) or if you’re ability to pay minimums each month is in question. Otherwise: highest interest first.

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  29. I just got laid off today. Is it too late to join the poverty party? I have essentially no debt, so I don’t have to cut corners to pay off loans. I have to cut corners to eat..

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  30. Emergency fund first Boss, and then pay off CC debt. If emergency fund is in place, you won’t be charging your cards back up when the fridge goes out, or you get bad highlight (j/k)

    We have kooties this week. Frugal hindsight http://jlogged.com/

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  31. I think the irony is that this article is in a magazine that costs more than my first car.

    As for debt, we go back & forth on this one. Especially student loans, which will be fully paid when out youngest starts college.

    xoxo, SG

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  32. I transferred all our credit card debt to one card with a low interest offer that does not expire. First and only time i’ve seen that! That card is not being used for anything else. If we do have to resort to a card we use our lowest interest card and pay it off at the end of the month. Like Sewmouse advises I am bringing the big balance down by paying the minimum due + that month’s interest + whatever further amount I can manage that month. So slowly slowly we are crawling out from under. In the meantime I am trying not to buy things that I can’t get for points……………see this post for my latest success at that!

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  35. Who is this Dave Ramsey guy everyone’s so gaga over??

    I think AFTER you pay your credit cards off, “paying yourself first” should almost be unnecessary BECAUSE – it should be just like paying your monthly mortgage bill or your monthly car payment or anything else monthly. It should be factored into your budget and you should stick to it.

    At least that’s what I do, except during Christmas. And speaking of Christmas, http://wherearethebears.blogspot.com/2008/12/shes-crafty.html

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  36. I don’t know about Dave Ramsey or the money questions at hand, but because Bossy forgot to close the italic after her quote, everybody afterwards is leaning to starboard and is making me even dizzier than I would have been just reading all this. It’s even making ME lean to the right as I sit here. Help me….

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  37. I am hardly qualified to read this post, much less contribute to a discussion on the topic.

    You don’t spend what you do not receive, which is why 401(k)’s and other similar employer-sponsored plans are great…because you are paying yourself first AND there usually is some matching contribution, where matching contribution equals FREE MONEY.

    Having said that, though, I’ve recently had to drastically reduce my 401(k) contribution because I needed the $$ in the check. So nevermind.

    See opening remarks.

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  38. Late to this party – but I paid off the highest interest ones first and STILL paid myself. I started out only paying myself £25 a month and as each debt went to zero, I would take the amount of that payment, pay part onto another debt and another little bit into savings. It was slow but at least I started building a little cushion for emergencies alongside paying off debts. Took me 5 years and by the end of it, all my debts were gone, all the money previously going into payments was going into savings and I started letting myself spend a little more on myself each month. That was 6 years ago and, er, I’m starting again!!!

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