I’m constantly asked how one should pay off debt. It’s extremely hard to answer, because it’s generally based on personal experiences and preferences. That being said, I firmly believe in paying off debt and saving money at the same time. Why? It’s because that’s how I did it and I showed it was possible to pay off all your debt and build yourself a healthy emergency fund. Not only is it possible, but it’s great to start your new financial journey with money in the bank.
As some know, I worked my way through $50,000 worth of credit card debt ($75,000 overall) from irresponsible borrowing and spending. There is no one to blame, but myself. I have learned a valuable lesson from my journey into and out of debt, so I want to make sure I share all of the valuable pieces that I can.
This Free Tool Helped Me Pay Off $75,000
Sometimes all you need is free! I opened a free Personal Capital account back when I was in debt and it helped me get control of my financial lifestyle. Since paying off $75,000, I’ve been able to save over $180,000 and I couldn’t have done it without Personal Capital.
Paying off my debt and saving at the same time changed my money mentality. When I was in debt, I was making spending number one and saving number two. After I paid off my debt, I switched and make saving number one and spending number two. This the mentality that I want to have, so I am glad that I used my strategy.
There are some that think that it is unwise to save while paying off debt. They tend to say that it is not good financially because you are getting charged interest. They talk about the basic sense of mathematics. While I love mathematics, debt isn’t truly about mathematics. Yes, you get into debt because you spend more than you make, but most people are dealing with emotions. Emotions push us to make bad money decisions and that is why debt is so rampant. If paying off debt was just about mathematics, then no one would use the Debt Snowball. Alright, enough about math, lets talk about the method I used when paying down my debt.
I created a dedicated page to show you how my debt/saving allocation method works. You can read more about it and see if it might work for you.
My Payoff and Saving Allocation
Any of you that invest know about investment allocations. Your allocations can be deemed as aggressive, moderate, and conservative, plus a few more in between. I used the same type of strategy with my debt payoff. Instead of just allocating all of my extra money to my debt, I decided to allocate some to my savings account.
My first step was to find out how much I could allocate toward my debt payment. This number is going to different for each person, but this is necessary. Once you know how much you can afford to pay toward your debt each month, then you can come up with your debt/saving allocation.
I started out with a 95/5 allocation. What this means is that I allocated 95% of my payoff money toward my debt. The 5% was then put into my savings account. For a simple example, if you have a payoff allocation of $100, then $95 will go toward your debt payment and then $5 will go toward your savings account.
Related Read: How to automate your savings with Digit
This allocation was also placed onto any extra money that I got each month, whether it be from side income or work bonuses. It is a simple strategy, but it is quite effective.
When to Change Your Allocation
Whether you create an aggressive or moderate allocation toward your debt payoff, you will have to change it after some time. I changed mine after I hit some milestones that I set for myself in the beginning. I went from a 95/5 allocation to a 80/20 allocation at some point. This means that I was still pushing 80% of my payoff money toward my debt and 20% toward my savings account.
As time moved toward the date that I would payoff my last credit card, I changed my allocation to push more money into my savings account than towards my debt. My last allocation came in at around 60% into my savings account and 40% toward debt. You have to find a point when you will change your allocation. You can create certain milestones or goals that you have to hit before you change the allocation or you can do it whenever you feel. It is up to you.
What is the Point?
I am sure there are some of you asking what is the point of doing this? Why should you save money when you are in debt? Well, as someone who was in a lot of debt, I can tell you that saving money is all about creating a new mindset.
Even saving a small amount of money, you are doing something that you haven’t before. You are actually saving money. You are not spending that extra money and putting yourself into more debt. We have lost our saving mentality that used to be the mainstream. We need to get that back and the only way to do it is to save. Until you create this new mindset, you will be stuck in an endless cycle of paying off debt. That’s now a way I want to live and I hope none of you want that either.
Another reason why this is a successful path is because you are building up a cash reserve. Usually when people pay off debt, they are pushing everything they have at their debt. They get to the last payment and then realize that they have no extra cash left. They have nothing available for other purchases or emergencies. With this strategy, you are building up your savings account while you pay off debt. When you make your last payment, you are making a payment to yourself. If you put money into savings during the whole debt payoff, then you will be ready to face the world debt free and with a good start for saving.
Related Read: How to build an emergency fund
I am trying to change the mentality of money here, not just worry about math. I understand math and I know how it works, but money is not just about math. We use money based on emotion, so we have to change how we feel toward money. I am happy that I used my method because I now feel bad when I don’t put money into my savings account or investment accounts. I feel even worse when I spend. This new mentality has me on my way toward financial freedom.