Is it Better to Save or Pay Off Debt? in 2021

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is-it-better-to-save-or-pay-off-debt

If you have outstanding debt and have disposable income, there may be a conflict as to whether it is better to save or pay off debt.

Juggling debt while worrying about building your savings can really strain a person. While there isn’t one right answer for everyone, here are scenarios where either choice – paying off debt or saving – makes more sense.

is-it-better-to-save-or-pay-off-debt

Paying off debt may feel like it has to be your only financial priority. However, you should save a little while you pay off your debt. Even a small pillow of emergency savings can keep you from going deeper into debt when unexpected expenses arise.

Which is More Important? Pay Off Debts or Savings

Paying off debts and saving money are important financial goals. They are also steps you must take to achieve a bigger goal in life – a good life in retirement.

You may want to retire debt free, but if you focus on paying off debt now, you may have to forego building your retirement savings.

You may need to take a mixed approach and save some while paying off some of your debt at the same time. Understanding the pros and cons of just paying debts or just savings will help you better assess your own situation and see how you can optimize your savings and debt payments to advance your goals in each area.

When Should Saving be Prioritized?

There are a number of good reasons to save first and pay off debt later.

Some of the main reasons are:

  • Debt with a very low interest rate
  • Access to an employer’s 401 (k) match program
  • No emergency savings

If you have a credit card or other debt with a very low interest rate, it can make sense to save first.

Another situation where it makes sense to save before paying off debts is if you have access to a retirement plan through your job, especially if an employer match is available.

If you postpone saving for retirement until you are out of debt, it can cost your most precious asset: time. With compound interest, even small contributions to your retirement plan can grow significantly.

The main reason saving is our number one priority over paying off debt is to build your emergency fund. Without saving any money, you could simply increase your credit card debt to pay for an unexpected car repair or trip to the emergency room.

If you don’t have savings, focusing on paying off debt can backfire when unexpected needs or costs arise. You may need to borrow again, and debt can become a revolving door.

Saving that first – and building a decent emergency fund – could mean the difference between difficult times and winding up in a bankruptcy court.

How much is to be saved?

Experts recommend building up an emergency fund with expenses worth three to six months and storing it in a savings account. Some even recommend putting enough cash in the bank to cover your expenses for a full year.

When should debt repayment be prioritized?

If you have high-interest consumer debt, paying off the first time can solve the problems of managing your money.

You get a guaranteed return when you cut your interest payments. It’s usually more than you make in the stock market and definitely more than you would make in a savings account.

To start paying off your debt, there are four things you should look at:

  • Calculate your consumable income (what’s left after taxes, bills and groceries)
  • List all of your regular expenses (even if they are regular) and see if there is anything you can eliminate
  • Create a budget based on this number and include debt settlement as an essential part of the equation

It also helps identify your financial goals so that you can prioritize them in your budget. In this case, we assume that paying off debt is your top priority.

Including a monthly repayment in your budget will better ensure that you still have money left over for essentials.

Another option is to transfer the credit card balance. That way, you can put all of your credit card debt on one low-interest card and save money on financing costs.

What do I need to do to save and be debt-free?

Once you’ve established your basic savings, focus on paying off your toxic debts such as payday loans, credit cards with interest rates above 15%, car loans, and hire purchase payments.

You should focus on these first as their high interest rates can devour your budget and create a debt spiral.

A debt repayment calculator can help you see when you are out of debt with your current payments, and how much faster you can reduce debt if you pay more every month.

Knowing when to need help is also important. You could be a good candidate for debt relief if:

  • You are struggling to meet your minimum requirements and see no way to pay off your debt in five years.
  • Your total unsecured debt is greater than half your gross income.

Tools like a debt management plan from a bankruptcy non-profit credit counsellor can help you pay off your debt faster.

More savings and offset remaining debt

When you have your toxic debts under control, you can build up greater cash reserves and retirement savings while you work to pay off the rest of your debt.

If you stick just enough into your 401 (k) to get the match, you can add more to it. Save up to 15% of your gross income for retirement.

Student loans, credit cards with interest rates of 15% or less, or car loans may be easier to manage, but creating a plan to pay off your debt is still important.

How to pay off debts

To get out of debt, first focus on getting rid of your most expensive debts. That probably sounds easier said than done. Here’s how to see where you are, then strategically attack your debt:

  1. Take a deep breath and be honest about what you owe. If you’re not sure, check your credit report which shows your outstanding balances. Make a list of your different types of debts, their amounts and interest rates, which you can find on your bank statements.
  • Prioritize paying off high interest debt first. Credit cards, personal loans, and payday loans should be high on the list. High-interest private student loans may also be a priority for you.
  • Consider using a balance transfer credit card or debt consolidation loan to lower your interest rates and combine multiple debts into one so they can be more easily paid off.

You can also consider refinancing private student loans at a lower interest rate. (When you refinance federal student loans, you lose access to protections like income-based repayment and long delayed payments.)

  • You may also be able to cut down the monthly payment on some debts if you need a strategy that will make it more affordable in the long run. For example, federal student loans come with income-based repayment plans that tie your payments to income. Payments can be $0 if you have no income.
  • To free up more money for debt payments, increase your income. They could sell unused clothing, rent a guest room on Airbnb, or ask for a raise and send in extra income for the debt.

If you are feeling overwhelmed or need help creating a debt free plan, a non-profit credit counsellor can review your situation and offer solutions.

How to save

There are two main categories of expenses that you can cut down to save money: fixed and variable. Fixed expenses are recurring bills that don’t change, like your rent or mortgage, while variable expenses like entertainment and food can vary from month to month. This is how you can address both:

  1. You don’t know where to save if you’re not sure where your money is going. Make a budget so you can assess what you’re spending and where there is room to trim.
  • First, target your largest monthly expenses such as rent and transportation. Moving to a cheaper location, finding a roommate, or refinancing your mortgage can provide huge savings. Buying a used car instead of a new one, or buying cheaper car insurance, could also help lower monthly bills.

Consider using a balance transfer credit card or debt consolidation loan to lower your interest rates and combine multiple debts into one so they can be more easily paid off.

You can also consider refinancing private student loans at a lower interest rate. (When you refinance federal student loans, you lose access to protections like income-based repayment and long delayed payments.)

  • If you’ve already saved major expenses, or are currently unable to make changes to your accommodation or transportation, the next step should be to consider smaller monthly bills such as billing. For example, negotiate your cable or internet bill or buy a new mobile phone tariff.
  • Next, look at the variable expenses. If eating is a big part of your budget, try cutting out the takeaway for a month to see how much you save, or just eat out once a week instead of three.

Spend the week cooking on Sunday afternoons so you can bring leftovers to work. Cancel all subscriptions that you are not using, e.g. Gym membership or streaming video or music services.

What is the best Approach to Saving and Debt?

The best solution might be to strike a balance between saving and paying off debt.

You may be paying more interest than you should, but savings to cover sudden expenses keep you out of the debt cycle.

In addition, sufficient savings ensure safety. Some people are unlikely to be comfortable with a strategy that will cause their savings to fall below a certain level. For them, saving and paying off debt at the same time might be the best approach.

Paying off debt is important. It can be difficult to save when a large portion of your money is used to pay off debts. That’s why it’s important to have a plan for getting out of debt – it can save you money on interest rates and ultimately help you save more and reach your goals faster.

Conclusion

Saving and paying off debt are perhaps the most rewarding financial goals to pursue, but you can feel at odds. To avoid losing sleep due to competing priorities, consider creating a plan that looks at your emergency fund in turn.

The more you accomplish – even if it takes you five minutes to set up a monthly auto referral from exam to savings – the more you know you can do.

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