Should I save or pay off debt?
It’s a tough financial choice. Prioritizing debt repayment can help you pay off what you owe faster, eventually freeing up more money that you can save. It could also cut down on what you pay in interest charges. On the other hand, delaying savings could mean missing out on the power of compounding interest.
Whether it makes sense to pay off debt or save depends largely on the specifics of your financial situation, your needs, and your goals. The right decision might actually be to try to do both.
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Debt can wear you down mentally, emotionally, and financially. Collectively, Americans owed $15.84 trillion in household debt as of the first quarter of 2022, according to the Federal Reserve Bank of New York’s Center for Microeconomic Data. Whether you owe a credit card balance, student loans, personal loans, or a mortgage, here are some of the main advantages of choosing to pay off debt first:
Eliminating debt also means that you can lower your baseline cost of living. So instead of needing $5,000 a month to cover your expenses, you might be able to trim that to $4,000 instead, provided you can pay off a $1,000 monthly debt payment. Reducing monthly expenses can make it easier to get through a financial crisis or emergency should one come along.
If you’re debating whether to pay off debt or save, it’s helpful to think about your bigger financial picture and goals. For example, you might put debt repayment ahead of saving if you:
That last point might be the most important. If you’re not all-in with your debt payoff plan, then you might not get much in return for your efforts.
If you’re ready to pay down debt, the first step is knowing what you owe and to whom. You can start by making a list of your debts, including the creditor’s name, account balance, APR or interest rate, and monthly minimum payment, and how long it’s projected to take to pay down the debt.
Once you know what you owe, you can formulate a plan for paying it off. There are different strategies to become debt free that you can put to work.
Some of the most popular options include:
If you’re struggling to find the right debt repayment option, you might consider meeting with a nonprofit credit counselor or financial advisor. Guidance on financial planning for debt reduction can be very helpful, and organizations like the National Foundation for Credit Counseling (NFCC) can connect you with advisors.
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It pays to look at the other side of the issue when you are wondering, Is it better to save or pay off debt? Understanding the benefits of saving can help you to decide. Here are some of the main advantages of prioritizing saving:
Saving is crucial if you’d like to avoid racking up debt in an emergency. If your car breaks down or your dog needs surgery, for instance, you can use your emergency fund to pay those expenses rather than having to rely on a high-interest credit card.
The decision to save vs. payoff debt also depends largely on your goals and what your financial situation looks like. You might prefer to save first and pay off debt second if you:
It’s important to note that there’s a difference between savings vs. investing. When you save money, you’re earmarking it for some future expense which might be planned (say, a down payment on a house) or unplanned (in the case of an emergency fund). You might put your money in a savings account, money market account, or certificate of deposit (CD) account where it can safely earn interest.
When you invest money, you’re putting it into the market. So you might buy stocks, mutual funds, or other investments. Investing money has the potential to deliver higher returns than saving it. But there’s a greater risk of losing money.
Making saving a regular habit can take time and effort. You may have to bypass little splurges (takeout food, for instance) as well as larger ones (joining pals on a vacation to Paris). But finding easy ways to save money can help you get into a routine of setting aside money. Here are a few ways you can do just that:
If you’re struggling to find motivation to save money, try setting one or two small financial goals. For example, give yourself a goal of saving $1,000 to start your emergency fund in the next 60 days. Challenging yourself this way can help you get fired up about saving. If you’re able to knock out some smaller goals fairly quickly, it can get you solidly on the path to save more.
Whether you can pay down debt and save money at the same time will depend largely on your budget and how much you can dedicate to either goal. If you don’t have a firm budget in place, making one can help you see at a glance how much money you have to pay down debt or save.
So, say you make your monthly budget, and you have $1,000 left over after all your regular expenses are paid. Your current debt payments total $500 per month.
In that case, you might decide to keep paying $500 each month toward the debt and put $500 in savings. That way, you’re working toward both goals equally. If you’d like to prioritize paying off debt vs. saving, then you might pay $750 per month to debt and cut the amount you save down to $250.
Saving and paying off debt at the same time might be ideal if you can find the right balance between them. Again, it all comes down to whether paying off debt or saving takes first priority on your list of financial goals.
An emergency fund is designed to help you pay for unplanned expenses or unanticipated events. For example, getting laid off from your job could be a financial emergency if you don’t have any other income to fall back on. Other examples of financial emergencies include unexpected appliance repairs, vehicle repairs, vet bills, or medical bills.
Sixty-four percent of U.S. adults say they’d be able to handle a $400 emergency in cash, according to the Federal Reserve. But that means roughly a third of Americans would have to turn to debt to manage an unexpected expense. That’s a lot of people without a financial back-up plan. It may be wise to prepare and put some funds away in case a rainy day strikes.
Starting an emergency fund makes sense if you don’t want to be left scrambling to pay for unanticipated expenses. Even a small emergency fund of $1,000 could be enough to help you weather most minor emergencies. Once you save that amount, you could then work on building a larger emergency fund.
Of course, you may not need an emergency fund if you have substantial savings, investments, or other assets to draw on in a crisis. For most people, however, this is not the norm, so an emergency fund can still be an important part of their financial plan.
Saving money and paying off debt can both be central to improving your financial situation. Whether you prioritize one over the other or tackle them both at the same time, it’s important to understand how saving and becoming debt-free can help you to get ahead and build wealth.
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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
SoFi Checking and Savings is offered through SoFi Bank, N.A. 2022 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
SoFi members with direct deposit can earn up to 2.00% annual percentage yield (APY) interest on all account balances in their Checking and Savings accounts (including Vaults). Members without direct deposit will earn 1.00% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. Rate of 2.00% APY is current as of 08/12/2022. Additional information can be found here.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SoFi Checking and Savings is offered through SoFi Bank, N.A. 2022 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
SoFi members with direct deposit can earn up to 2.00% annual percentage yield (APY) interest on all account balances in their Checking and Savings accounts (including Vaults). Members without direct deposit will earn 1.00% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. Rate of 2.00% APY is current as of 08/12/2022. Additional information can be found here.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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