HomePersonal FinanceWhen Paying Off Debt Remember How Important Liquidity Is

When Paying Off Debt Remember How Important Liquidity Is

Cat Fight
Liquidity vs Debt Repayment Cat Fight

I was reading Financial Samurai’s recent post how he won’t be paying off his mortgage on a rental property for years despite having enough cash to do so and it really stuck with me.  While FS makes it clear he has enough liquidity to pay off a mortgage on a second property I am in a similar situation minus a couple of zeroes.  I have enough liquidity to almost completely eradicate my debt on an auto loan and a healthy student loan balance I choose not to because liquidity is just too damn important (I have NO credit card debt).  Since getting serious about my personal finances a couple years ago I have taken a pretty balanced approach to paying down debt vs. investing/saving.

I think it is nuts that there are bloggers out there that will only keep a $1,000 balance while attacking debt.  What kind of emergency can you solve with just a grand? My balanced approach is that every dollar is split between (there is no exact percentage):

  • Living expenses & Minimum Debt Payments (401(k) is included in there since it is all automatic)
  • Liquid Savings
  • Perpetual Income
  • Extra Debt Payment on Auto Loan

However in the past few months, I have been attacking debt aggressively, which has made me start to miss (if that is possible) the amount liquidity I could have had.  Then I remember my favorite thing about paying off debt and then it turns into a cat fight than in my head.

Increased Liquidity vs Debt Repayment

I have paid off a little bit under $7,000 on my auto loan in the past 10 months (most of that in the last 4), but how much sexier would it be if my liquid cash account was $7,000 bigger?  And there lies the problem.

I am trying to reach an internal balance between wanting liquidity for an eventual home purchase (we will be selling our condo in a couple months), maybe investment opportunity, etc.  vs. reaching my goal to be debt free and all the awesomeness that comes with it.  It is simple yet complex concept that,

Every dollar I pay towards debt is one less dollar I have in my liquid cash account or investment accounts

This should seem obvious to most, but with the speed that I have been paying down debt in the past 4 or 5 months has really affected how much more I could have saved/invested, and I am not too sure I am alright with that.  When I pay my auto loan balance by another $250 or $500 that is liquidity I won’t see back for months until the debt is cleared, and on the law school loans that money won’t be seen for years.

Personal Finance Advice is Personal

This type of internal discussion I have with myself does provide one self evident truth.  Personal Finance is not one size fits all.  Is there a good reason I am not attacking my debt with the type of rampage that Dave Ramsey demands? Yup.  Is it a good reason? I think so as would most.  Does a lower Credit Card balance provide the type of liquidity that a job loss requires?

In the end I think I am going to continue my balanced approach with a cap on principal debt repayment set at $1,000 unless a large chunk of money comes through from my multiple streams of income (Law Firm of Evan,  this site, an online side business that has been booming, tax refund, etc.).  This allows for a semi-aggressive approach while making sure I am saving liquidity for the upcoming changes in my life.

Is Dave Ramsey Right, am I being an idiot? Should I just focus on getting out of debt? 



  1. Interesting topic to think about.

    Personally, I decided to pay off my debt (auto loan and student loans) as soon as possible and pass up the potential extra liquidity. For me, it came down to simply looking at the interest I was paying on my loans compared to the interest I would earn on my money sitting in savings.

  2. I agree that liquidity is important. And when you look at low cost debt it is easy to justify not paying it back early – in my opinion. Now if the debt were costing above 10% it gets very hard to justify not paying it back early.

    Also, remember, for many people, paying down debt is improving their liquidity position. True if your only option is paying debt of putting it in saving AND NOT SPENDING it then this isn’t true. But many people are going to spend what they have available. For those people, paying off debt means you have freed up your future liquidity position (because you removed an recurring reduction in your cash position each month). This is one reason why paying off extra on a loan can make real sense – even when technically it could seem wiser to just put the extra in savings each month.

  3. I am debt free except for a small mortgage which will be paid off in six years. Since auto loans like other consumer debt is not tax deductible, I would pay it off or transfer the balance to a HELOC. I would still pay it off quickly, but it would be tax deductible, a lower interest rate and liquidity.

  4. I agree with you. I am constantly amazed by bloggers who post that they don’t have an emergency fund (or have a small one) or who aren’t putting any money towards retirement, and are pouring thousands of $$ into their debt.

    I understand if someone is really underwater by debt and needs to bail hard, but when you’re in a decent position, IMO, having an emergency fund and putting something aside for retirement at the very least is CRUCIAL.

    • It is scary! I read the posts and I cringe sometimes…they paid of $10K in CC debt but have next to nothing in the bank? What happens if something went down.

      • I gotta defend the $1,000 emergency fund only in the case that you’re in credit card debt.

        Here’s my rationale for paying the debt off first: if you pay the credit card off, in all likelihood, if you had an emergency, you could run the credit card up again if you had to. By paying the credit card down, you saved interest in the interim, and the emergency fund would have gotten a paltry and likely taxable return in a savings account. Honestly, an emergency fund is really a mechanism to avoid credit card interest rates when you need money. If you already have credit card debt you’re being charged interest on, you’re not avoiding squat with a larger emergency.

        No, this strategy I fully admit is not perfect. What if the credit card company lowers your limit, or cancels your card right when you need it? etc. But there’s also no answer for the burden of crushing credit card debt, either. You might as well pay it down if possible.

        When you’re in that position, all alternatives are less than ideal. But you know for certainty you will be paying high interest on the credit card debt you already have instead of worrying about an emergency you might not face, and even if you did, you probably could whip the credit card out again to get through it.

        • As long as you can make a coherent argument then I love opposing views! I guess it may be a different situation when you are paying 17% on a credit card…but even when I was in 18K of credit card debt I took a balance approached rather than just keep a grand or two in the bank.

          I may have not done it “the right way” just highlighting Evan’s thoughts lol

  5. You’re not an idiot. 🙂 I agree that it’s a balancing act between paying down debt vs. building liquidity. We tend to go in one direction for a while and then head in the other.

    I think even Dave says that personal finance is personal. I’ve heard him recommend that people bump their $1000 emergency fund if their income varies from month to month or they see storm clouds on the horizon. I think he also assumes that people are going gung ho to get out of debt when he recommends thate $1k, and that’s no always the case.

    • When does the CEO decide to switch courses? Do you hit a certain milestone and then decide to go the other way? or is just based on feelings

  6. Personally, I’d pay off the debt as soon as possible. But like you said, personal finance is personal. It’s a balancing act for oneself and family.

  7. The danger of liquidity is that you will find a way to spend it. A bigger car, more nights out to eat, etc., because your bank account looks to have more money in it. I think our focus on our financial plans has waned in times when we’ve had extra liquidity.

    Also, for dudes like you and me that have big grad school loans, even Dave says to beef up the emergency fund, since we’re not talking about a 24 month plan to be out of debt, but rather years.

    If your pay-off-debt plan is multiple years, you can’t go wrong either way so long as you have a healthy ER fund to back you up should crisis hit.

    What I really wonder, is which is higher – the number of people who read this entire article, or the number who just clicked on the picture to see more of the cat fight ;o)

  8. If you’re saving for a house, then I think liquidity is very important.
    Being debt free is good, but sometime there are more important things – like baby momma’s emotional health. 🙂

    • Hahaha baby mama’s emotion health is #1! The Mom used to say, “When Mama ain’t happen nobody is happy” lol cheesy but true

  9. I have the same cat fight going on in my mind, except not with 2 gorgeous blond babes. Mine are more like old grannies beating each other with their purses. Anyway, I definitely lean more toward debt reduction with the comfort of knowing that once my debt is paid off I’ll be able to pile up cash and invest much easier. It’s a trade-off I guess, but I’m really anxious to KILL my debt quickly. Best of luck…

    • You have to have a healthier attitude than old grannies!

      Its true that once the debt is retired you’ll have more cash free, but how long is that going to take? I have about 65K in school loans that is a lot of years of living without those extra principal payments

  10. As Dave has said many times, “if you had a paid off car, would you take out a loan on it just to increase your liquidity?”

    That said, what you’ve paid off over the last 10 months is about what both mine and my wife’s cars cost added together. They were purchased with cash some years ago and they’re still doing fine.

    Patience is a virtue.

    • Would I take a loan out to increase my liquidity? Sure, if the money was cheap enough and I needed it for some reason or emergency. and therein lies the rub – I can’t do it and that is the problem with aggressively paying down debt.

      What kinds of cars do you have?

      • ’97 Ford Escort wagon and a ’99 Merc Tracer wagon. We bought them used for $4,700 and $3,000 respectively. They look like twins in the driveway because they’re both white. Not the coolest looking cars, but they’re very fuel efficient and handy for hauling stuff as well.

        The Escort now has about 270,000 miles on it. Each car has had a $2,000 repair needed, but doing the repair was better than buying another car or having car payments.

  11. Add me to the club. I really struggle with saving vs. paying down debt because there are so many good arguments against both. If I focus on saving, I’m in debt longer. If I pay down debt, something will eat up my emergency fund and I’ll be disgusted. For now, I’m using a combination of both – I’m paying extra toward my debt, but I also save as much of my income as possible. I’m still getting out of debt faster than I would by making minimum payments, but at least I know I have a backup plan if something goes wrong in the meantime.

    • The balanced approach is fantastic! It has worked for me. Your comment makes me feel good that I am not alone.

  12. To be honest, I think it comes down to two elements, personal and finance.

    You’ve a BS in economics, so I’m sure you well understand very basic ideas like opportunity costs, economic institutions, and structural rigidity.

    To pay off debt at 4% and change, in my opinion, never makes sense. In fact, load me up with all the debt in the world at that price, I’ll borrow a billion!

    I don’t mean to sound like there isn’t any qualitative value in paying off debt–it’s fun, you see progress instantaneously, and it’s generally risk-free.

    But it can also be pretty stupid, too. As far as I see it, the qualitative is outweighed the second you understand the quantitative. People latch onto the idea of being debt free minus their home (thank Dave Ramsey!), which does appease the mind, but quantitatively, it’s not always the best way to go.

    tl;dr – If you understand the logic, screw the touchy-feely.

    • You have a point – in my life I am a numbers guy…why am I letting the feel good debt repayment enter into it too much!

  13. I’ve had the same cat fight plenty of times, and basically just drew a line in the sand. If debt interest is more than 2% GREATER than the risk free rate of return on the 10 year yield (2%+3.5% yield = 5.5%), then I will consider paying off the debt quicker.

    If not, I’ll just go with the normal debt payback schedule, and throw in some money here and there if I’m feeling frisky.

    I can’t have an auto loan or credit card debt though. That is my personal feeling.

    • I really like the line in the sand approach but why the 10 year yield? If I have the money sitting in an ING account then why wouldn’t that be the barometer (even though it is embarrassingly low)?

  14. I think when you are talking about credit card debt, then liquidity is less important. There isn’t much that you cant buy with a credit card should you run into an emergency… so I wouldnt accumulate cash earning low interest while paying high interest on credit card debt.

    • Great point, but I still worried about liquidity when I was paying down credit card debt. True I could always charge more but there was no guarantee that the credit line wouldn’t be reduced.

  15. I think it just comes down to what you are comfortable with as far as debt vs. liquidity. The main thing for most people is learning to be disciplined enough to live within their means and to save their money. What they do with their savings is the fun part!

    • “what you are comfortable with as far as debt vs. liquidity.”

      Correct but my point was that I often find that people don’t even think about the comfort of liquidity when they are so focused on the debt repayment.

  16. I think if the debt makes you money like rental property, then it’s okay (aka good debt).

    If it’s consumer debt, then it’s okay too if you make enough to keep the wealth building process ball still rolling. But if you keep getting deeper, and Deeper, and DEEPER into debt… then no, consumer debt is a bad idea.

    I’ve never read Ramsey, but does he even preach that rental debt should be eliminated? If so, that kind of undermines the principle of leverage…

  17. excellent post and what a way to conclude. you nailed it Evan with your comment on personal preferences. many discount the fact that personal finance is very personal. the premise of your post however is sound. i am fortunate to be in a situation where i can pay cash for my assets and maintain the liquidity that makes me sleep comfortably at night. what also helps is a diversified stream of income, which makes one more confident, more willing/likely to take risks and therefore inherently have the chance for more upside

  18. My approach:

    Credit card/high interest – pay agressively. I forgot the emergency fund – if I owe 30K on credit cards and have 1K in the bank, I’m still broke! Just don’t call the credit card companies and say, “I just lost my job, can I have more credit?”

    Low interest (car, house, etc.) – liquidity is more important to me. My field is hard to find work at times – so 1 year cushion plus retirement savings plus college for my kids plus…. There’s just not enough to go around to save for all I want to save for plus pay down debt agressively. (Even if you think you could find work easily – do you have 6 months expenses saved?)

    I do make an exception when the payment % to total balance goes over 5% – at that point it makes sense to refinance something or pay it off quickly.

    • It is great that you give thought to the issue. How many people are just floating through life not understanding how important liquidity is.

      What do you do that contract work is hard to come by?

      • I’m in healthcare in an area where my area is somewhat oversaturated in my field, so finding a job would require a major move or starting from scratch ($400K) where there’s already a lot of competition.

  19. We’ll see what happen this week if the congress can separate their differences and get to a deal (debt) or will let the US goes into a long recession.


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