It’s not uncommon to be faced with the question of which is better for your financial health, saving or paying down debt. Though it’s a common question, the answer isn’t necessarily clear-cut, as it depends on many factors and your situation.
That said, there are a few pros and cons to each method that you’ll want to consider before setting up your plan to save or pay down debt, which we’ll examine below.
Understanding Savings & Debt
Before you can assess the pros and cons of the different financial options available to you, it’s important to clearly understand savings and debt, as these will impact your decision-making.
Savings are the money you set aside after paying for your living expenses. This money helps you build financial security for your future and work towards short- and long-term financial goals, such as buying a home or retiring. The money you set aside is also how you build an emergency fund or the money you have on hand in case of emergencies or the unexpected, such as losing your job or fixing your vehicle. It’s generally recommended to have three to six months’ worth of expenses set aside in an emergency fund.
Debt is the money you owe to others, and it comes in many forms, including credit card debt, student loans, and mortgages. These different types of debts have varying interest rates and differing effects on your financial health and credit card scores. Credit card debt is the most common type in the US and is usually a high-interest type that impacts your credit score. Student loans and mortgages typically have lower interest rates and only impact your credit score if you miss regular payments.
Pros and Cons of Saving First
When it comes to prioritizing your savings, you’re setting yourself up for success with long-term goals, as these do better over longer periods of time thanks to compound interest. Prioritizing your savings also allows you to build an emergency fund, which can help cushion you from incurring further debt should something happen. The drawback of saving first is that you will owe more interest on your debt, sometimes outpacing the interest you may earn from your savings.
Pros and Cons of Paying Down Debt First
Paying down your debt first allows you to limit how much interest you’ll pay and can help you get your credit score back in shape. However, if you prioritize paying down debt first, you miss the time needed for savings to grow over the long term. You may also find yourself going further into debt if something unexpected happens.
How to Approach Your Savings & Debt Payments
After reviewing these pros and cons, you likely feel neither approach is ideal for your situation. Because of these variables, both of which have major long-term impacts, many choose to have a dual focus where they’re building some savings if they don’t have any already while also paying down debt. Below are several strategies that can help you balance paying down debt and saving.
Create a Budget
Reviewing your income, expenses, and debts through a budget can help you allocate your financial resources to meet your living expenses and financial goals of saving and being debt-free. You can do this by reviewing your pay stubs, bills, and other costs, including online gambling through a curated list with 120 spins or subscriptions to online services and adding them to a budget template. This will let you see how much money you have to work with at the end of each month to put towards savings and debt. It can also help you identify how to save more on your monthly living costs so you can put more towards these goals.
Build an Emergency Fund
If you don’t currently have an emergency fund, most financial experts recommend making this your top priority. To make the most of your emergency fund, use a high-yield savings account so that the money you set aside can earn interest while still being easily accessible. Once you have three to six months’ worth of savings, you can readdress your budget to reallocate your funds for debt payments or other saving goals.
Automate Savings & Minimum Payments
Setting up automated payments to your savings account and the places you owe money can help ensure you consistently work towards your goals and aren’t late or accidentally missing payments.
Compare the Snowball vs. Avalanche Method
With high-interest debt repayment, people typically use two main approaches: the snowball and avalanche methods. The first suggests taking on your smallest debt, paying it off, and moving on to your next lowest debt. While this means you’ll pay more interest, it motivates you because you can more prominently see your progress. The second method involves tackling your highest-interest debts first so that you’re paying less interest in the long run. Here, the decision comes down to which method will help you feel the most motivated about reaching your debt-free goal.
Consider a Zero-Percent Balance Transfer
If you know you’ll need time to pay off your credit card, a zero-percent balance transfer may be a good option. This allows you to refinance your debt for a balance transfer fee, usually 3% to 5%. This fee is a small amount compared to annual credit card interest rates, which are generally over 20%. Using a zero-percent balance transfer will usually give you 6 to 21 months to chip away at your debt without incurring more interest. Before using one, be sure you thoroughly understand the terms and conditions and do the math to see if it will save you money; many free calculators can help you with this. If you’re not careful, you could make your situation worse.
Conclusion
Many people debate whether to save or pay down debt. The correct answer or approach varies depending on your situation, but thankfully, there are many different strategies and tools to help you find the best solution for you, your finances, and your peace of mind.
Featured Image Credit: Pexels / Charles Thompson.
The content of this article is for informational purposes only and does not constitute or replace professional financial advice.
