Is It Better to Pay Off Debt or Save?
Is It Better to Pay Off Debt or Save?
Quick Answer: It entirely depends on your financial situation. You must prioritize creating an emergency fund first, then contribute to retirement savings, and finally, focus on paying off high-interest debt. Follow these steps to guarantee your financial security.
When we talk about managing your money, one repeated dilemma is deciding if you should pay off debt or save. Both of them are highly important - but what’s more important? Figuring out which to tackle first is not an easy feat. There’s no restricted answer here, as it depends on your circumstances. Let’s break it down into manageable steps to assist you in making the best decision.
Step 1: Set Up an Emergency Fund
Before you focus on anything else, you must set up an emergency fund. This fund will be your safety net for unexpected expenses. It can be anything such as medical bills, car repairs, or a sudden job loss. Without it, you can be forced to rely on credit cards, which will ultimately increase the debt.
Financial experts recommend setting aside three to six months’ worth of living expenses. Don't start too big - starting small is perfectly fine. A $1,000 cushion is a satisfactory initial goal.
Why is this important?
According to a 2022 Bankrate survey, 56% of Americans wouldn’t be able to cover a $1,000 emergency with savings. It is highly important so you don’t derail your progress when life throws a curveball.
Step 2: Contribute to a Retirement Fund
This thought may seem absurd when you already have debt lingering, but it's helpful. If you are starting early, it gives your investments more time to grow through compound interest. If your employer provides 401(k) with a match, contribute at least enough to get the full match.
Let’s say you invest $100 per month starting at age 25. By the time you’re 65, you could have nearly $150,000, assuming a 7% annual return.
If you have high-interest debt on your shoulder such as credit card balances, you can allocate only the minimum to retirement savings until your debt is under control. Once high-interest debt is paid off, you can increase your contributions.
Step 3: Pay Off Debt
After you focus on the above priorities, it's time to pay off your debt. Here is how to decide which to tackle first:
High-Interest Debt vs. Low-Interest Debt
High-interest debt: Credit cards and payday loans come with the highest interest rates of 15% or more. This should be on the priority list.
Low-interest debt: Mortgages, or student loans with rates below 6% are less urgent.
Three Popular Strategies to Pay Off Debt:
The Debt Snowball Method: Pay off the smallest debts first for quick results and psychological motivation. Once a small debt is paid off, roll that payment into the next smallest debt.
The Debt Avalanche Method: Pay off debts with the highest interest rates first. This method saves the most money in the long run but demands patience.
Debt Consolidation: Combine multiple debts into a single loan with a lower interest rate. It's a favorable strategy to decrease the total interest you pay.
Wrap Up!
Saving or paying off debt is not an either/or decision. You can create a balanced way that guarantees your financial security and saves you money in the long run. If you are still confused, we recommend seeking professional help! Our experts are here to assist you. Contact me now!