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Pay Off Debt or Save?

Jan 15, 2020

Pay Off Debt or Save
Deciding between whether you should pay off outstanding debt or open a savings account can be difficult, as they’re both very important things you should do. Below, we’ve detailed some things you should consider when deciding which to prioritize.

Paying Off Debt Before Building a Savings Account

Paying off any outstanding debt before building a savings account ultimately helps to minimize the total amount of interest you’ll pay, so depending on your interest rate, it may benefit you to pay off your debt as soon as you can to avoid paying more in the long run. Additionally, by reducing the balance of what you owe, you’ll reduce the amount of interest you pay each month. If you have extra money after paying your bills and expenses, you should prioritize your high-interest outstanding debt over other debt in an effort to keep the total amount you’ll spend in interest down.

Despite these benefits, prioritizing paying off debt over establishing an emergency fund could cause you to end up deeper in debt if you find yourself in an unexpected financial emergency. It’s very important that you have your own emergency fund set aside because you never know when you’ll need it. A Bankrate survey showed that 36 percent of Americans would either borrow money from friends or family, take out a loan, or use credit cards to handle a $1,000 emergency. This ultimately racks up new debt and makes it harder to pay off existing debt. Keep in mind that if you wait too long to start saving, though, you might not have enough when you need it – and the last thing you want is to be in debt!

Building a Savings Account Before Paying Off Debt

If you prioritize opening a savings account, you can build an emergency fund more quickly. Most finance experts recommend that your emergency fund has enough money in it to cover 6 to 12 months of unplanned expenses, as this cushion is meant to keep you afloat should you become unemployed or another emergency arises. However, if you feel that 6 to 12 months is too tall an order, you can start smaller, by saving enough to cover 3 to 6 months of expenses. If you have high-interest outstanding debt, some experts say you should aim to put at least $1,000 into an emergency fund before turning your full attention to paying off the rest of your debt. Once the debt is paid, you can return to growing your emergency fund.

However, prioritizing a savings account means you could end up paying more money in debt interest charges over time, as debt interest rates are higher than savings interest rates. You also risk letting your debt grow to the point where it becomes unmanageable and even enter retirement with debt, so be mindful that if you choose to prioritize your savings you aren’t neglecting any outstanding debt.

If one of your financial goals is to save enough money so that you’re financially stable during retirement, take steps now to build a 401(k), especially if your employer offers to match your contributions. You’ll start saving for retirement and someone else will be contributing as well – it’s a win-win!

The money in your savings account can get you through a rainy day, and if you don’t need to spend it right away, it’ll grow for years and you’ll reap the benefits of compound interest. Because paying off debt is equally as important as having an emergency fund, you should try to find ways to do both simultaneously. If you have an extra $1,000 each month, consider using half to pay off outstanding debt and put the other half into a savings account so that you can tackle both tasks at the same time. Saving and paying off debt can seem like two daunting tasks, so take it slow and don’t stretch yourself too thin trying to accomplish either task.

Erin Ellis

Erin Ellis
Accredited Financial Counselor ®
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