In personal finance, one question that persists is whether it’s best to pay off debt or save as much money as possible instead. Unfortunately, this question has no straightforward answer, so it’s still debatable.
It’s better to focus on paying off your debt first instead of saving if you have expensive debt that will cost you more money in the long run. However, prioritizing saving and investing makes sense if you have affordable debt and can get a significant return by doing so.
This article will dive deeply into both sides of this debate to help you decide what’s best for you. On top of that, you’ll also learn why setting up your emergency fund is the most important thing to do before making any other decisions.
The decision to save or pay off debt hinges on factors like interest rates, the presence of high-interest debt, and individual financial goals. In general, prioritize paying off high-interest debt before saving, as it minimizes long-term costs, but if your debt is manageable and offers the potential for significant returns, consider saving and investing. Striking a balance between building an emergency fund, addressing high-interest debt, and saving for future needs is often a prudent approach.
Here is a glance at some concerns in the saving vs. debt-paying discussion where people often disagree:
As you can see from just these 3 points, there’s a lot to consider when deciding whether you should prioritize saving or paying off debt.
The rest of this article will help you understand which option would be more beneficial based on your situation.
Saving should take priority over paying off debt when the debt is manageable, At this point, it’s clear that you have two options: prioritize saving first before paying off debt, or focus on wiping out your debt instead of saving as much as you can. Consider the first option: saving before dealing with your debt.
You should certainly do this if you don’t yet have a large enough emergency fund. As you read earlier, nothing else in your personal finances matters until you have enough money saved for a rainy day.
Still, there are situations where prioritizing saving and investing over paying debt makes sense despite already having an emergency fund.
Suppose you’re in a situation where your debt charges low interest rates, and you know that you can receive exceptionally good returns through your savings or investment accounts.
In that case, it would make better financial sense to prioritize saving over everything else. That’s because you could benefit more in the long run by saving as much of your money as possible while paying the minimum on your debt.
Paying off debt should take precedence over saving when the debt is expensive, potentially incurring higher costs over time, and addressing it promptly is financially beneficial. Of course, there are also conditions when you should be paying off your debt aggressively while slowing or pausing your savings.
For example, if you’re struggling with high-interest debt, it’s always best to focus on paying it off before saving or investing. That’s because a high-interest debt of any kind will cost you more money the longer you have it.
Worse yet, it could cost you so much that you’ll find yourself spending whatever returns you get from saving and investing just to pay off that debt.
If that’s the situation you find yourself in, start by saving enough for emergencies. Then, it’s best to spend every available dollar you have towards wiping out that debt as quickly as possible.
In almost all cases, you should pay off the debt with the highest interest rate first.
Like most people, you likely have more than one debt to pay off. As a result, you have another decision to make: which debt do you pay off first? For starters, you should stay current on all your debts and make the minimum payments for them. Doing so will prevent additional costs like late fees and other penalties.
Then, you can prioritize your debts based on the amount or interest rates.
Focusing on your high-interest debts first can help you save a lot of money in the long run. That’s because paying them off will reduce the amount of interest you’ll have to pay throughout the lifetime of that debt.
However, you can also choose to prioritize your debts based on their outstanding amounts. Focusing on paying off your smaller debts first can give you a strong sense of progress, keeping you motivated in the long run with small and quick wins.
The "debt snowball" and "debt avalanche" are the two best approaches for quick debt repayment. These two approaches to prioritizing debt described above are incredibly common in the personal finance space. As a result, they’ve come to be known as the most effective strategies for debt reduction.
Here’s a closer look at each of them:
People find success with both of these strategies, but you shouldn’t base your choice on others. Your ability to pay off your debt will depend on choosing the strategy that fits your personality and preferences.
Yes, it’s possible to find a balance between saving and paying off debt by using a budget and planning well. However, you must remember that the longer you take to settle your debt, the more it could cost you in the long run. Ideally, it would be best to focus on saving until you have enough in your emergency fund before switching towards paying off your most expensive debts as quickly as possible.
Overall, remember that there is no one-size-fits-all solution when it comes to prioritizing saving or paying debt. That decision depends on your personal financial situation.
Still, you shouldn’t make any decisions until you’ve built a large enough emergency fund to cover yourself. Then, you can decide if you should prioritize saving or paying debt.
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Here’s one thing that everyone can agree on regarding personal finance: nothing else matters until you have enough money set aside to help you get through a financial emergency.
Suppose you prioritize paying off your debt without having an emergency fund set up. In that case, the danger is you might face a crisis that forces you to borrow even more money through debt. As a result, the situation will erase any progress you’ve made so far in reducing your overall debt levels.
However, saving too much and building your emergency fund beyond what’s necessary also has drawbacks. When you save too much and don’t prioritize debt payments, you could end up spending more of your savings on paying the interest over the long term.
The key here is to build an emergency fund to an appropriate size first. Then, you can reevaluate your personal finances and choose between prioritizing saving or paying off debt.
Having an emergency fund is crucial, and knowing how to size it correctly is another important thing to do.
Remember: a well-sized emergency fund will help you get through a crisis with as little stress and anxiety as possible. However, it doesn’t need to be too big, especially if you’ve still got debt to pay.
The rule of thumb in personal finance is to have an emergency fund enough to cover 3-6 months of your expenses. In other words, you should save enough money to keep all of your bills paid for 3-6 months in case you receive no income for whatever reason.
Despite that, many people also prefer maintaining a 12-month emergency fund instead.
Here’s how you can decide how big your emergency fund should be:
As you plan your emergency fund, there’s one thing you must always remember: no matter how big your emergency fund is, there is always a chance that it won’t be enough.
The reality is that some emergencies are costly and can cost you more than whatever you have saved up.
That’s why you must have a backup plan to complement your emergency fund just in case it’s not enough. As you read earlier, finances aren’t just about the numbers. So, pairing a well-sized emergency fund with a good backup plan can benefit you mentally and emotionally, thanks to the peace of mind they offer.
Simply put, that peace of mind comes from knowing that you can handle whatever financial emergency comes your way by combining your saved-up emergency funds and a quick loan if necessary.