Which comes first: pay debt or save money?

If there’s anything I have learned from writing about personal finance, it is this: pay debt as soon as possible. Do not be held hostage to it. It can cripple you and your family because as J. Reuben Clark says:

Interest never sleeps. It never gets sick. It works on Sundays and never goes on holidays.

But what of those who are seriously trying to clean up their act? Which one should come first? Pay debt or save money? Do both at the same time? What is the best strategy?

Our Money Myth Buster today is: pay debt first.

Even experts are divided on what should be done. Some say do both, some say pay debt first. Others say it’s a no-brainer, pay debt first. On closer look, however, the answer is not immediately obvious.

Consider this. A couple I know is trying to pay for a second-hand car. They both decided that they needed it; they have a growing family. They responsibly went for a humble model.

But cash flow became a problem, what with several illnesses in the family. To cope with their cash flow problems, they first turned to their company cooperative. Then a credit card became very convenient. Swipe, swipe, swipe, and a hasty postscript while signing the charge slip. “We’ll pay the amount when the bill arrives.” But somehow, despite good intentions, they never do.

The couple is not trying to burn their credit card with purchases of Kellog’s and Hershey bars and Dove soap. They understand the risk of not saving enough and buying too much. They ask: We have a P50,000 bonus coming in. Should we use this to add to our savings for emergency, our pension plan and insurance plan or pay off our debt first?

MoneySmarts says separate the good debt versus bad debt, and without hesitation, pay bad debt as soon as possible.

“Not all debts are bad. Some are good, like a car loan. You can buy it on credit and treat monthly amortizations like rental. After all, cars depreciate. But if it were me, I would pay the credit card debt 100 percent first. The interest is just too high,” Henry Ong, president of RFP (Phils) Institute, says.

Pay-debt-first strategy works, but it has to be finetuned. Separate the good debt from the bad debt. Then pay off the bad debt with the highest interest first. As much as possible, keep socking away some amount for your emergency fund so that you don’t have to rely on credit cards again in times of emergencies.

Most credit card companies, for example, charge 3.5 percent interest monthly. Credit card interest rates here never go down, at least in my lifetime they haven’t. Interest just keeps going higher.

At 3.5 percent, that’s a hefty 42 percent interest per annum. If you are investing in an instrument that gives an eight percent return per annum, for example, you know that the interest you’re paying for consumer loans will just eat up your earnings.

Unfortunately, credit card debt is not the only trouble spot here in the Philippines. There are worse things – like paluwagan, 5-6 and other kinds of loans with astronomically high rates. Believe me, they still exist and sadly, those who are victimized are the ones who really can’t afford the interest.

Other kinds of debt, like a home mortgage, car loan, even a student loan, have a time and place in everyone’s lives. Done in accordance with a long-term financial plan, they can empower and strengthen financial foundations. But any debt based on overspending and boosting self-esteem with goodies is like dead weight that will pull down any serious investor.

Until you know how to manage debt, it’s almost impossible to save and invest. Until your debt is in control and part of your life plan, you will not achieve financial freedom.

Suze Orman said that. I agree. A good quote, especially for Filipinos.

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