If you’re a typical American, you probably have some sort of consumer debt and are actively saving your money either in stocks or in a general savings account. Unfortunately, those two things don’t go hand in hand. Deciding to pay off debt or boost you savings is a tough choice. The best decision for you might not work well for someone else. It is entirely dependent on where you are at financially. Let’s dig deeper and take a look at some of the positives of each scenario:
Positives of paying debt off first
-No worries about owing a bank;
-Your income is freed up;
-Less debt, higher credit score;
-Negative cash flow ratio.
Positives of boosting savings first
-Cash cushion for negative events;
-Freedom from the banks;
-Use your money for things you’ve always wanted to do;
-Save more for retirement.
Take a look at those interest rates
What most Americans fail to do is compare apples to apples in regards to their respective interest rates. Go ahead, go get your credit card statement and get your bank statement out. Compare the two interest rates. If your credit interest is at 15% and your savings interest is at 1.5%, then the obvious choice would be to pay off your credit cards. It makes sense to avoid giving your money away for free to credit card companies. The sooner you pay off your debts, the sooner you can start boosting your savings.
Also, it’s important to compare your interest rates to your 401(k) and Roth-IRA plans. If you foresee greater gains in the coming years or have a company match, postponing credit card debt payments might be your better option. [Edit: Make sure you always pay at least the minimum due!] Again, this comes down to interest rate comparisons. For example, if your employer offered a 50% match, a 50% rate is much greater than a 15% credit card interest rate. Therefore, it would make sense to invest in your 401(k) first.
Don’t forget emergency savings
Before I go on any further, I want to point out the fact that it’s critical that you have enough in emergency savings. Your emergency fund savings account trumps retirement investing as well as credit card payments. If you find yourself with credit card debt and zero emergency fund savings, then you need to consider paying the minimum amount on the credit cards and boosting your emergency fund up to 6 month’s worth of expenses. There is no debate on this logic. You need this cash cushion for unforeseeable expenses!
Try a combination
This is an approach that I like to take with my finances. Oftentimes, debt is inevitable. Sometimes you just can’t do one or the other. I have found myself saving and at the same time aggressively paying off consumer debt. This will take a bit of strategy but is very effective in the long run. You don’t want to find yourself in a position with zero savings. So, when you receive a paycheck, take a portion and save it. Take another portion and pay off the highest interest credit card debt or car loans. This way, you can attack two birds with one stone.
To each their own
As you can tell, there are no absolutes in this debate. To give you an answer on whether to save or pay of debt, IT DEPENDS! At the end of the day, you need to have a clear goal in mind to keep you on the path to success. The longer you stay at it, the more rewarding it will become. Maybe it’s a car you’re searching after. Maybe it’s a new guitar. Or is it that new photo printer? Whatever the case may be, hold yourself back and refuse to buy anything else until both your savings are boosted and consumer debt is paid off. Once you get back in the habit of paying for things in cash, you will cherish those items that much more knowing that you own it, not a bank.
I like your point about no absolutes. Every situation is different. While I am lucky to not have any debt, I would also suggest that if you have enough extra income to put towards debt, you should put the majority towards the debt. If an emergency does come up, you can put it on credit. What’s the point of not paying off the high interest credit card and building an emergency fund that may or may not happen? I would probably keep a little cushion of cash/savings, but not too much to think that you have extra spending money.
Ahhh I recently had a post on my blog about this. I’m still unsure about how I’m going to budget and divide everything.
Personally, I’d pay off the debt unless there is an investment involved.
Very good question and it can only be answered by looking at your own financial position. Do you have 3-6 month or more emergency fund? Do you have other debt? Do you have other obligations that will be due soon? What does your cash flow look like for the next 12 months? Assuming you have an emergency fund I would pay off highest interest rate debt first.
I only have a small mortgage, but I make additional payments to pay it off early. I make savings for retirement a priority.
I think there should be a good balance between the saving and paying off debt. Consider this:
If you save and don’t pay off debt, you’ll be spending more in interest. If you pay off debt and don’t save, you might end up borrowing more when emergencies pop up.
Dave Ramsey has a great balanced plan with his 7 Baby Steps. I highly recommend checking it out!
I would divide my money into paying off my loans first. Afterwards, double up my savings by putting the money I previously used to pay my loans.
It really depends upon the amount of interest that an individual is paying and the expected amount of gains from the savings. If the numbers are close, then the individual should go with what makes them feel more comfortable.