Posted by Tim Stobbs on June 10, 2010
I’m often amazed how some people feel they aren’t saving much of anything. Then I ask them about how much are they paying off in debt. That is often a big number, so I point out that debt repayment and saving both increase your net worth. So in some regards debt repayment is the same as savings.
For example, I’m focused on paying off my mortgage right now. I’m currently doing my regular payments plus lump sum payments just about every month. Does that mean I’m not saving anything in a month? I personally feel its the same, since having no mortgage is just as critical to my plan as having a good size pool of money invested. Yet on the other hand, are you really saving if you are just making the minimum payments on your credit card bill? In this case the increase of your net worth is minimal so you could potentially argue that it isn’t like saving.
Thus we can be into a interesting paradox where some debt repayment could be like savings, while other debt repayment may not be. So what debt repayment is like savings? At this point it might be easier to take a step back and determine one of the core tenets of personal finance: are you spending less than you earn? Yes? Good. Now are you still spending less than you earn if you consider interest payments as spending? Yes, good job. No, then you are not saving overall. In the end if your interest payments shove you over what you make in a month you are in a debt spiral. Your debt will continue to grow regardless of your ‘savings’. So you would need to take drastic action to free up enough cash flow until you are spending less than you earn.
In the end, paying out debt might be like savings but in general I would say that only really applies if you are making significant payments towards the principle. Otherwise if 95% of your payment goes towards interest, calling it savings is deluding yourself. But what if it is tax deductible debt? The math gets more complicated to determine what you are paying in interest on a net basis, but ultimately the same idea applies.
So would you call debt repayment the same as savings? Also does it matter where the debt came from?