What Should I do - Save or Pay Off Debt?
Wednesday, July 8, 2020
Read time: 3 mins
You may be wondering if you should be increasing your savings or paying off debt. Everyone’s finances are different, and no one size fits all or one approach is best for everyone. However, the best approach to deciding whether to save or pay off debt is best for you is to determine your financial priorities. Some questions to ask yourself to determine where to start may be...Do you have an emergency fund? Are you paying high-interest rates on your credit cards? By taking a look at your financial picture, you’re able to better assess your current income, savings, and the debt you owe.
So, should you save or pay off debt? It may seem impossible to do either, especially during these uncertain times. The pandemic has left us concerned about the economy and job security. However, with a plan (better known as a budget) and determination, you can find a balance to accomplish both simultaneously to help you reach your financial goals.
It’s not what if something happens, but when will it happen. Life tends to throw us off track from time to time, and the pandemic is a good example of life happening. Paying off debt is important, so is saving and planning for the future. Building savings helps you prepare for the unexpected, avoid debt, gain a greater sense of financial freedom, and relieve you of the burden of financial stress.
Establishing an emergency fund is essential to your financial health. It helps protect you when the unexpected happens – job loss, a flat tire, a broken appliance, a sick pet, a trip to the emergency room, or doctor’s visit. The unexpected can impact your budget, and it can cause you to go further into debt if you’re unprepared.
Financial experts recommend saving six to eight months of living expenses. But this can seem daunting. Start small and work your way up using smaller increments as your goal. If you’ve found it difficult to factor in a budget for savings, try paying yourself first. Instead of relying on what’s leftover at the end of the month, you can set up an automatic draft to send a portion of your paycheck into a savings account. By paying yourself first, you remove the temptation to overspend (out of sight, out of mind), and you increase your savings over time. Also, you could even consider using a money market account to hold your emergency fund to earn more interest than your checking account.
Paying off debt
If you’re in a position to continue paying off your debt and possibly paying more than your monthly payment, then repay as much as you can towards that debt. Ultimately, paying down your debt frees up additional money you could use to boost your savings.
If you're serious about tackling your debt, it helps to approach your debt with a repayment plan. Know who you owe and how much you owe. Start by listing your debt with the highest interest rates (credit cards, payday loans, and rent-to-own payments) to the lowest interest rates (student loans and auto loans) and the balances. This list will give you a clear picture of all your debt. Two of the most distinct ways to start paying off your debt are the debt avalanche and debt snowball methods. These plans will help you achieve your goals of being debt-free.
The debt avalanche method allows you to pay the minimum payments on all your debts with focusing all of your additional funds towards the debt with the highest interest rate. The goal is to tackle the debt with the high-interest rate first. This method can result in lower payments over time and save money on interest.
The debt snowball method focuses on making the minimum payments on all debts and applying additional funds towards the smallest balance. Once the lowest balance is paid in full, you add that amount to the next lowest balance. You repeat this cycle until your debts are repaid. The snowball method allows you to continually build momentum with each balance payoff. With this method you are able to see results faster and feel a sense of accomplishment.
No matter if you are concentrating on building your savings or becoming debt-free, create a budget and stick with it, cut the credit cards, trim your expenses, add a side gig to earn some extra cash or explore debt consolidation.
Everyone's situation is different, and there is no right or wrong choice or one method to get you there. Whether you choose to focus on saving, paying off debt, or balancing both, it's up to you. The right choice is the one that is best for you - one that will motivate you to stick with your plan.