A common question most struggle with when starting their personal finance journey is what should I do first, pay off debt or save? Overwhelmed with trying to make the ‘right’ decision, 1 of 2 things happen:

1. They try to do everything with no strategy with minimal to partial success
2. They do nothing and hope that it will eventually work out

Like any goal, the key to paying off debt and saving is to have a plan that you can follow.

This article presents a simple strategy that uses a phased approach that is determined based on specific milestones.

You might ask, “Can’t I follow the Dave Ramsey Baby Steps to paying off debt?” The answer is yes you could, but this approach leaves you vulnerable to unexpected events such as a job loss.  The baby steps recommend saving $1000 for emergencies, then aggressively eliminating all consumer debt.  But what if your emergency is greater than $1000 or if you are un-expectantly laid off?  Most recently, like in the government shutdown, what if your employer decides not to pay you for over a month?

If your rent, utilities, and food bill are more than $1000, at a minimum, you need more than $1000 saved.  If not, you would go back into debt to cover your living expenses anyway.

In this article, I recommend a phased approach to paying off debt and saving based on targeted thresholds based on your personal financial situation. This provides greater protection for you and your family during an unexpected event while helping you build your credit score as you pay down debt.  Additionally, you will learn:

• Ways to save your first month expenses
• The most effective debt repayment strategies
• Actions steps to get you started

Save 1 Month of Living Expenses and Make Regular Debt Payments

When faced with the situation of paying off debt or saving, you should make it a priority to save at least one month of your mandatory living expenses.  Mandatory expenses include expenses needed to survive and maintain your household.  Some examples include:

• Shelter
• Utilities
• Food
• Transportation (if needed to get to work)

This should be the bare minimum that you and your family need to weather the storm.  Even though I know some people may view cable as a necessity, it’s not and it doesn’t need to be included in this amount.  Hair and nails also do not constitute as a need. Ladies, I know…don’t come for me. 🙂

When calculating your one month expenses, only include items needed to live.

Having at least one month of expenses reduces your risk exposure to an unexpected loss of income.

The Job Perceived as Most ‘Secure’ is Unstable

This couldn’t be more apparent than during the recent government shutdown which lasted over 30 days and impacted over 800,000 families, including me.  There were several heartbreaking stories of families lined up around the block for an opportunity to get free groceries.  There were also several news reports of families urging Congress to open the government because they didn’t know how they were going to pay their rent/mortgage.

The White House also recommended employees to negotiate work for rent or mortgage payments.

These employees had ‘good government’ jobs and they never expected to be without pay for not 1 but 2 paychecks.

It was unprecedented, but you know what? We are in unprecedented times.

This is Another Wake-Up Call

This is another wakeup call, for you to get your financial house in order.  If your monthly expenses are more than $1000, why are you intentionally not saving enough?  One month of living expenses gives you at least 30 days of breathing room to:

1. Figure it out OR
2. Figure it out

Either way, you have the money in place to stay afloat while you…figure it out.

How To Save One Month’s Living Expenses

I know some may ask, how am I going to save one month of expenses? I’m glad you asked.  There are only two ways to meet this requirement:

1. Reduce Your Expenses
2. Increase Your Income

Those are the only two ways to do it.  If you want to accelerate your journey, do both.

More importantly, when you save the money (because I know you will), you must have the discipline to not touch it.

“You have to be comfortable with having money in your bank account.”

Most are accustomed to spending all that they earn as fast as they get it.

This mentality must change. Allow the money to stay in the account so that it is available when you need it.  Think of this as your personal protection.

Lastly, save this money in a separate account.  This account should be in a separate bank from your checking account to reduce the temptation to transfer the funds back and forth.

 Action: Calculate Your Mandatory Living Expenses to Determine How Much to Save.  Create a separate savings account and don’t touch it.

Pay Down Debt to at least below 30% of Debt Utilization

Now that you have saved at least one month of expenses, it is time to focus on paying down your debt. Notice that I did not say pay off all your debt (yet), but the focus of this phase is to pay down your consumer debt to the lender’s acceptable threshold of 30% utilization.

Utilization is the percent used from your available credit limits.  For example, if you have a credit card with a $1000 limit and you use $1000, your utilization is 100% because you used all of your available credit. In this scenario, you should only report using $300 or 30% of the total limit.

Your debt should be 30% utilization or lower for 2 reasons:

• You will be considered a low-risk borrower
• You will be eligible for better interest rates

With a higher credit score, you will also likely receive offers to consolidate high-interest debt to a minimum to zero interest rate.  At this point, you can accelerate your debt payments with minimum interest charges.

Which Debt Should You Pay Off First?

There are 2 strategies for paying off debt:

• The Debt Snowball
• The Debt Avalanche

The Debt Snowball

The debt snowball is a debt repayment technique that recommends that you pay off the debt with the smallest balance first and then once that debt is paid off you use that money to pay off next highest debt.  The focus of this technique is to gain confidence through quick wins to keep going.

Here is an example:

Tami has $500 to allocate to debt repayment and she has 3 credit cards with the following balances and minimum payments:

Credit Card	Credit Card Balance	Minimum Payment
Discover	$350	$25
Chase	$800	$75
Barclays	$1200	$75

Tami’s Debt Snowball Strategy

Tami would allocate the following:

• Chase – $75
• Barclays – $75
• Discover – $350

Next month, Tami would use her same $500 and do the following:

• Barclays – $75
• Chase – $425
• Discover – $0

Once the Chase card is paid off, the full $500 would be applied to the Barclays balance.

The Debt Avalanche

Unlike the debt snowball, the debt avalanche factors in the interest rates when deciding which debt to pay off first.  This strategy will reduce your total interest payments overall.  The debt with the highest interest payment is paid off first.  You would make minimum payments on all other debt.

Using the example above, Tami’s interest rates are:

Credit Card	Credit Card Balance	Minimum Payment	Interest Rates
Discover	$350	$25	15%
Chase	$800	$75	10%
Barclays	$1200	$75	19%

If Tami selected the debt avalanche strategy, she would pay off the Barclays credit card first because it charges the highest interest rates.

Next, she would apply the minimum payment to the remaining cards until Barclays was paid off.

Whichever strategy that you choose, the key is to be committed to the strategy and stop using credit while paying it off.

“You cannot pay off debt and accumulate debt at the same time.”

However, in our debt repayment phased approach, Tami still needs to build her cash reserve balance.  Once she reaches 30% debt utilization ($705 remaining balance), she should continue to pay down the debt, but also build up her savings at the same time.

Fund 2 additional months in your cash reserve

Now, that you have at least 1 month saved in your cash reserves and paid down the debt to the ‘acceptable’ level, it is now time to build up your cash reserve to at least 3 months of living expenses.

Having at least 3 months of cash reserves further protects you from the loss of income and provides greater flexibility to respond to unexpected events without crippling your budget.

“With cash reserves, what used to be an emergency is now just an inconvenience.”

Some advisors recommend at least 3 to 6 months of living expenses in a cash reserve.  However, your next target should be 3 months.  Continue to build your reserve balance and soon you will have a comfortable reserve fund and be consumer debt free.

Final Thoughts

Once you complete these steps, you will have a solid foundation to take your wealth building to the next level.

You will be comfortable with having money in your bank account and not have the urge to spend it. You will be able to spend below your means and not use credit to borrow against your future.  When you have this down, you are ready to accelerate your wealth building.  You will be better prepared to purchase your first home, rental property, and start investing.

Skipping the fundamentals can be detrimental to your financial success so I encourage you to be patient, stack your cash reserve, and pay off consumer debt.

That’s getting your FINANCES ON POINT.