Is it Better to Save First, Pay Off Debt, or Both?
Like everyone, you have financial goals you want to achieve someday. Maybe it’s buying a car, buying or building a home, saving for college, taking a trip abroad, starting your own business, or saving for retirement. Like many people, you may also have debt that seems to get in the way of saving for your financial goals, whether it’s credit cards, student loans, or other debt. It can be difficult to prioritize if it’s more important to save money or pay off debt, or if it’s even possible to do both at the same time.
The answer depends on several factors, and is unique to your financial situation. Here are some things to consider when deciding for yourself whether you need to prioritize paying off debt first or saving money, or if it’s feasible for you to conquer both at the same time.
Your Savings
Do you have an existing emergency fund? It’s always recommended to have a financial cushion to fall back on when life throws you a curveball. If you’re just getting your savings started, start with a small goal and build up from there. Once you have a few hundred in savings that could help you through a minor emergency, work on building your savings from there until you have enough to cover you in case of a major setback. It’s okay if you can only start small at first. The sooner you start saving, the better off you will be in the long run.
Your Total Debt
Start off by taking a look at the balances you’re carrying on your credit cards, loans, and any other debt. Do you have high debt balances compared to your income? Do you pay off your cards only to turn around and rack up more charges right away? Calculate your total debt compared to your total income. If your debt is around 10-20% percent of your income, though it’s not ideal, you can probably pay that amount off within a year or two without making huge adjustments to your budget. However if your debt is 25% or more of your income, that will take a lot longer to pay down and will require big sacrifices to get there.
Your Interest Rates
Credit card interest rates can be quite high, depending on what type of card you have. Some credit cards have interest rates upwards of 20%. Thankfully, student loans and other loans tend to have lower interest rates, usually between 5-10%. It’s important to know the interest rate on all of your debt so you can know how much you are paying in interest payments each month, then determine your best strategy for paying down your balances thus reducing the amount of interest you owe. If you have high interest credit cards and loans, shop around to find a better deal. Compare rates online so you can find the card or loan that works best for you. Another step you can take to help you save on interest is consolidating your debt with a personal loan or performing a credit card balance transfer. Consolidating your debt to one loan or credit card can help you get a lower, more manageable interest rate and make it easier to pay off debt with one payment. If you take advantage of a special introductory offer with a lower interest rate, try to get your balance paid off before the introductory rate expires so you can make the most of your debt consolidation. With a lower interest rate and easier payments, you can even take some of the money you were putting towards debt repayment and put it towards savings so you can pay off debt while working towards your savings goals!
How Serious is Your Debt?
Your debt situation may or may not have reached emergency status. If you feel like you’re drowning, you’ll need to take more drastic measures to get your head back above water. If you’ve gotten behind on loan or credit card payments, especially if your accounts have moved to collection status, you need to focus on getting back on track with your lenders and getting your account status back to current before you divert any of your finances towards saving. If your debt has reached emergency status and you have emergency savings, it’s okay to pull from savings to help you get your debt under control, as long as you commit to repaying your savings once your debt is managed. If you are looking to make a major purchase soon like buying a home or a car, lenders will look at how much of your monthly income goes towards debt payments. So if you have a high debt-to-income ratio, bringing this number down may increase your likelihood of being approved for a loan and securing a better interest rate. In this case, it will be best to focus on paying down debt as your short-term goal so you can secure an interest rate that works best for you in the long-term. If your debt is still within manageable levels, you can put some of your money towards savings while focusing on paying down your debt.
In the end, your financial solution will need to match your financial situation. The decision of whether to save or pay down debt and how much of your budget to assign to each will need to be based on your unique situation and how much extra money you have to work with. If your budget is super tight, you might have to choose one over the other until you have more cash flow. If your debt has reached crisis level, that needs to take priority. If your debt is mostly low balances with low interest, you have the comfort to allocate extra funds to savings.
At Robins Financial Credit Union, our mission is to enhance the financial well-being of our members and community. We honor this commitment by providing educational content to help you make the most of your finances. Read our other blog articles to help you gain the financial knowledge you need to succeed.