“Should You Pay Off Debt or Save Money First?”

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When to Pay Off Debt Before Saving Money

It’s often more beneficial to pay off debt before saving extra money. Eliminating debt means you won’t have to pay hefty interest charges, which can add up to more than what you’d earn in a savings account.

However, there are times when saving is the better option. It’s crucial to have some emergency savings, even if it’s just $200 or $500 initially, with the goal of eventually saving three to six months’ worth of expenses. If you have no savings at all, try to set aside a small amount now.

When You Should Pay Off Debt Before Saving Money

In these situations, paying off debt should typically come before saving money:

• Payday Loans: These often come with extremely high finance charges, making it crucial to pay them off as soon as possible to avoid extra fees.
• High-Interest Credit Card Debt: With average credit card interest rates hitting 20.09% in February 2023, reducing this debt should be a top priority.
• Debt Impacting Your Happiness: If carrying debt severely affects your well-being, prioritizing debt payoff after starting an emergency fund is a worthwhile approach.

Pros and Cons of Paying Off Debt First

Benefits of paying off debt first include:

• Interest Savings: You save money on interest that you’d otherwise spend maintaining your debt.
• Lower Credit Utilization: Paying off credit card debt can boost your credit score by lowering your credit utilization rate.

Drawbacks include:

• Potential for More Debt: Without savings, unexpected expenses may lead to more debt.
• Missing Out on Investment Growth: Paying off debt before saving for retirement means losing out on compound returns.

When You Should Save Money Before Paying Off Debt

It may make sense to save first in these circumstances:

• No or Very Little Cash Saved: An emergency fund protects you from taking on further debt.
• Low-Interest Debt: If you only have low-interest debt like federal student loans or a mortgage, you can focus on saving.

Pros and Cons of Saving Money First

Benefits of saving money first include:

• Forward Momentum Toward Other Goals: Saving for retirement or a down payment can provide a sense of accomplishment.
• Security in Case of Financial Setbacks: Having an emergency fund can provide peace of mind during unexpected crises.

Drawbacks include:

• Little Additional Progress on Your Debt: Saving first means you could be debt-free sooner and save on interest.
• Continued Impact on Your Credit Score: Paying only the minimum on credit card debt keeps the balance high, affecting your credit utilization and score.

How to Pay Off Debt

Pay off debt by sending more than the minimum required to your creditors each month. Here are a few strategies to help you get there:

Debt Payoff Strategies

• Review Your Budget: Analyze your spending patterns and adjust to free up more money for debt payment.
• Cut Nonessential Expenses: Make changes like downsizing your cellphone plan and use the savings to pay off debt.
• Debt Snowball Method: Pay down the smallest balance first, then move to the next balance.
• Debt Avalanche Method: Prioritize the highest-interest debt first to save more in the long run.

Debt Consolidation Options

Debt consolidation can streamline payoff and potentially reduce your interest rate. Options include:

• Balance Transfer Credit Card: Move various balances to one card with a 0% interest promotional period.
• Debt Consolidation Loan: Bundle multiple types of debt into one loan at a lower interest rate.

How to Save Money

If you opt to save money first, start with an emergency fund in a high-yield savings account. These accounts are typically available at online-only financial institutions, which can be inconvenient if you deal a lot with cash. But for a savings account that you don’t plan to draw on often, the potential to rack up a lot of interest is an enticing perk.

Your next savings goal should be saving for retirement, since giving your invested money time to grow is an important element of long-term financial planning. If your employer offers a retirement plan—typically called a qualified plan—with a match, it’s an important benefit to take advantage of. Save at least as much as you need to—say, 3% of your income—to capture the full match offered.

Beyond retirement, you may wish to invest for short-term goals in a brokerage account, save for a home down payment, keep a specific savings account for vacations or save for a child’s college education. Identify the most important goals to you, then set up automated transfers to each account. You may even be able to send money directly from your paycheck into multiple accounts via a direct deposit split, if your employer offers it.

The Bottom Line

Both saving money and paying off debt are worthwhile goals, but with limited funds to work with, you may have to choose one or the other—at least initially. No matter which method you choose, keep an eye on your credit with credit monitoring. You’ll receive alerts when something changes so you can take action quickly to avoid hurting your credit score.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you navigate your financial journey with expert advice and personalized service.

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