Spending Cash Is the Same As Borrowing If You Have Debts

by Mike Holman

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A common financial strategy for someone who is trying to pay off their debts is to allocate some of their savings into a different account which might be used for some sort of fun.  The idea is that while you want to focus on paying off debts – ie have some gazelle intensity, you should also be realistic about your focus and give yourself some rewards along the way to stay motivated.

I think this is a perfectly reasonable thing to do although I would argue that someone who has excessive debt has already had their fun and then some.  One problem however is that sometimes people will make a purchase saying that they “saved for it” or “paid cash for it” which makes it a financially responsible action.

The fact is that if you have money in cash instead of using it to pay off debts, then you are essentially borrowing that money at the rate of your highest interest rate loan minus the net amount of interest earned on the cash (which these days is jack squat).  This is the logic behind not having a cash emergency fund (or not having a large one) since you are paying a high premium to keep the money in cash.

I’m not suggesting that everyone who has any debts shouldn’t buy anything non-essential until the debts are gone, nor am I suggesting that you can’t have some fun along the way.  What I would suggest is that you shouldn’t base any purchase decisions on how much cash you might have on hand but rather on your overall financial situation which includes your goals.  At the very least, don’t pretend that some of your money is “special” and doesn’t apply to the rest of your finances – it’s all one big bucket of money and debts.

If you are committed to paying off some or all your debts before taking any rewards then you should stick to that goal.  Having some cash in a different account or receiving some sort of bonus shouldn’t affect your strategy at all.  This is not to say you can’t change your goals (I change mine all the time) but don’t cheat on your financial plan

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{ 6 comments… read them below or add one }

1 Four Pillars

Rob, are you suggesting that I’m in some way negative? :)

Yes, I agree that once you have debt payments that your fun decreases. I was referring to the debt accumulation phase – hopefully that was fun.

2 Charles in Vancouver

I think the important question as to whether to have an emergency fund while repaying debt is: When you pay off the debt, do you lose the ability to re-borrow that cash? Or are you still able to borrow it again later?

The answer may depend on the type of debt. If you’re actively paying a line of credit off, the bank is likely to keep your credit room available. With a credit card, this may not be as likely.

If there’s a strong reason to believe you won’t be able to borrow what you need in an emergency, after repaying what you owe, that could be a reason to hold an emergency fund.

3 Mr. Cheap

Great post! I agree completely, and it’s a little frustrating when people in debt contort things like this to justify their actions.

4 Curtis

This makes complete sense; however, may not be the best health wise. Yes…you have had your “fun” when accumulating the debts, but if someone is making a genuine attempt to reduce debts, rewards are needed to keep them on the right track, having optimism, and practicing financial responsibility. My wife and I have a LARGE whack of debt and have been working continuously to pay it off…at the same time we needed/wanted a break so we saved up cash for a trip. We didn’t go until we had every penny we needed saved for that trip. I’ll tell you though, when we did go on the trip it was such a feeling of accomplishment and it helped proved to ourselves that we are able to do something (financially) when we put our minds to it).

5 Four Pillars

Curtis – that’s a good point. I guess the solution is to somehow find a compromise between “gazelle intensity” and having some fun as well.

There’s not much point on spending all your efforts on debt reduction and then burning out and going back to the old ways.

6 Nancy L.

I am in this situation, and while “gazelle intensity” might work for some people, it never would have worked for me. I know because I tried it many many times, even to the point of paying off my debt fully one time. Much like a dieter who *knows* they should eat smaller portions of healthier food, it wasn’t for lack of intellectually understanding WHY my habits were detrimental. It’s like losing 20 lbs, and then looking at a piece of cake. “Well, this one piece won’t be a problem! I’m doing so well right now!” Before you know it, you’ve allowed yourself so many “little” breaks, you’re right back where you started from, or in an even worse position. And then you feel so horrible about *that*, you just completely give up for a while. You’d think that the one time when I got to the point of completely paying off all my debt would have been a brand new start, but the problem was that I’d spent so much time denying myself “stuff”, that as soon as I was free and clear, I felt like I could go buy everything I’d been waiting for. So within a few months I’d racked up cc debt again.

The difference with me NOW vs me BACK THEN is that instead of just throwing myself into debt reduction, I decided to take things a lot slower. Before I even began to attack the balance of my debt, I spent time working on my emotions around spending. I experimented with budgets until I found a budget that allowed me just enough freedom that I didn’t chafe at the restrictions, but still kept me on track with my goals of paying off debt. When I had lived successfully under that budget for a year, I then figured out a plan of attack to get rid of the debt for good.

I will still be paying off my debt for 3 more years, which is incredibly slow compared to most people. During this same time, I’ve spent money on vacations and other things that would probably send Dave Ramsey and others into fits. But the difference is that I’ve found a method that works for ME. I now plan for these purchases, and save for months to raise the cash to pay for them outright, without taking a single dollar out of my debt reduction OR my emergency fund. This is the skill that was missing from my life previously–I didn’t understand how to spend money responsibly or the concept of delayed gratification. I kept telling myself I could just put purchases on cards and I’d pay it off eventually.

Instead of resenting my budget, it’s highly motivating for me to be able to work out spending plans at the same time that I’m reducing my debt. And, three years from now, when I’ve paid off this debt, I have developed the skills I’ll need to remain debt-free, so I feel highly confidant that I can make these changes stick. I think that spending more time to make a change for good is a lot better than spending a shorter time doing something that I wouldn’t be ready to maintain.

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