If you feel like you’re drowning in debt, you’re not alone. In 2021, household debt has risen to over 14 trillion dollars in the US alone. That’s a number so big, we have no way to even fathom it. It’s no wonder people are wondering whether they should prioritize whether to save money or pay off debt.
Being in debt is never a good feeling. Every time you spend money or dream of saving for something very special, debt always lingers at the back of your mind. And with rising housing costs, stagnant wages, and the major student loan debt crisis going on, it can feel nearly impossible to pay off debt.
So, it makes sense that you want to get it over with as soon as you can! But is that always the best option? It may come as a surprise to you, but in certain instances, it’s actually better to save rather than pay off debt.
Let’s break down how to determine whether you should personally save money or pay off debt based on your unique situation.
Understanding Interest Rates
Not all debt is the same, and this is the biggest factor in determining whether to save money or pay off debt. Simplified, there is low-interest debt and high-interest debt.
In determining what debt should take priority over saving, the first thing to look at is interest rates. The general guideline is if the debt has over a 7% interest rate, you should pay that off before you begin to save and invest. On the flip side, if the debt has less than 7% interest, you could start saving and investing while you work to pay it off.
I’ll go into more detail later about this, but essentially you can earn more money by investing the money you would put into paying off debt. Awesome, huh?
What Are Your Priorities?
Before knowing what to save and what to pay off, you need to understand what you need to live! You need to determine how much money you need to cover all your living expenses. To do this, you should track spending for a month to see where your money is going. This will help you see the areas where you’re spending the most and what you can cut back on.
Next, you have to build a budget. If you’re new to this, I encourage you to check out all the budgeting resources on the blog or to begin my free budgeting basics course. Ideally, once you have all your living expenses covered, you can then use the extra cash to build an emergency fund.
Building an Emergency Fund
Before you begin paying off debt, you want to have an emergency fund built up first. But why would you want to do that? You want to do this before paying off any debt so that you aren’t using credit cards for emergencies and accruing even more debt when you’re trying to pay it off.
An emergency fund should be 3-6 months’ worth of expenses (lean towards the higher end if you have a family). It’s best to put this aside in a high yield savings account so that you can earn as much interest as possible but still keep it accessible for emergencies.
Remember, this is not a shopping account. Emergencies are for anything unexpected such as medical expenses or the sudden loss of a job. By naming it as an emergency fund, it encourages you to leave it untouched.
Once you have your emergency fund figured out, it’s time to consider paying off debt or saving for your next financial goal.
Check out the best rates for savings accounts below:
How To Assess Your Debt
Now it’s time to prioritize your debt. This will help you determine the order in which you need to pay off debt as well as when you can begin saving.
There are several methods you can use to pay down debt. Here’s one of my favorites!
- Create a list or spreadsheet listing all your debt, their interest rates, and your minimum payment for each.
- Next, add up all of their minimum payments together to figure out a baseline for each month and what it will cost to pay them.
- Determine if you want to pay off debt using the debt snowball method or debt avalanche method.
Debt Snowball Method
- Look at what debt has the lowest balance and start there. You will want to pay extra toward that debt each month. This is on top of paying the minimum for all the others.
- Once that debt is paid off, work your way down to the debt with the next lowest balance and keep going unitl all your debt is paid!
- Continue this method until you become debt free or until you free up extra money each month to save a portion of your income.
Debt Avalanche Method
- Look at what debt has the highest interest rate and start there. You will want to pay extra towards that debt each month. This is on top of paying the minimum for all the others.
- Once that high-interest debt is paid off, work your way down to the debt with the next highest rate and keep going until your debt is all paid!
- When you’ve reached interest rates that are below 7%, you can begin to use some of the extra money for investing and saving as well as paying off the debt.
How Much Should I Save Every Month?
If you’re unsure how much you should be saving, you need to work backward from your financial goal. Whether that is saving for a vacation, down payment, or an emergency fund, determine how much you want to save and your time frame for achieving that goal. Then work backward! For example, if you want to build an emergency fund of $6,000 in six months, then you’ll need to save $1,000 a month.
Everyone’s savings plan will look different depending on your income and expenses. Whether it’s $20 a month or $2000, the important thing to remember is that you’re saving.
Don’t Be Afraid To Invest
While putting money away in a savings account is a great thing to do, it’s even better to invest that money. Money that sits in a bank account is barely growing when it could be earning you tons through investing. If you wait to invest until you’re completely debt-free, it just prolongs how long it will take you to get rid of your debt.
For example, student loans can take literal decades to pay off (unfortunately), so you don’t want to wait until you’re debt-free before you begin thinking about investing for retirement or a home. The earlier you begin investing, the better. Compound interest is when you earn interest every year in addition to your beginning amount. It continues to grow every year at a higher amount.
Most student loans and mortgages fall under the 7% rule. Even the most conservative investments make an annual return of 8-10%. If the interest is 7% or lower, this means you can use that extra percentage to earn money while also paying off your debt.
Find What Works for You
In the end, we all want the same things. To buy a house one day, to send our kids to college, to retire at a reasonable age, and to go on vacation every once in a while. Most of the time, these things cost a significant amount of savings that can be difficult to attain if you are continuously in debt.
If your debt is so high in comparison to your monthly income, it can take many years to get that debt down to zero, especially if it’s mostly high interest. When that’s the case, you want to also try to tuck away a little money each month in addition to your debt payments, so your financial goals aren’t put directly on hold.
Once you find a plan that works for you, stick with it. When you pay down your debt, you’ll be so good at putting aside money. It will feel so good when your savings begin to grow considerably due to you putting those previous debt payments entirely into savings instead.
Final Thoughts On Save Money Or Pay Off Debt
As you can see, it’s going to be a very different answer given your current financial position. The first thing you need to do is sit down and understand your debt so you can set your priorities. And then you can hopefully put yourself in a position to pay off debt while also saving for the future!
If you’re just getting started dealing with your debt and feeling overwhelmed, be sure to check out my budget life planner. It’s a quick way to keep your finances organized so you can work on paying off that debt and saving!