At a Glance
At a glance, paying off debt first makes a lot of sense. However, that approach doesn’t address the common cause of debt: unexpected emergencies. Learn how a blended approach can help you pay down debt responsibly without sacrificing future savings.
Understanding the balance:
Debt vs. Savings
If you’re torn between paying off debt and adding to your savings, you’re not alone. A high-level comparison of the pros and cons reveals the gray areas of an either/or approach.
If You Pay Debt Before Saving
You’re decreasing your debt and the amount you’ll pay in interest over time, which is good. But, without savings, you’re likely to turn to your credit card to cover unexpected expenses, adding to your debt. Also, by not saving, you’re missing out on compounding interest for retirement.
If You Save Without Paying off Debt
Saving money for the future is good, but ignoring debt altogether is not. Over time, you’ll end pay much more in credit card interest charges than you’d make in interest from your savings.
The Best Approach? Do Both.
We recommend a blend of saving and paying off debt. You’ll still be putting money toward debt, but prioritizing emergency savings first. Having financial resilience puts you in a better position to pay off debt later.
Make Savings a Priority
Many experts advise putting money towards critical savings before paying down debt. Critical savings include an emergency fund and taking advantage of employee matching.
Start an Emergency Fund
Unexpected medical bills, home repairs, and job losses happen every day. Without a small safety net, many people turn to credit cards. Others miss important payments, like their rent or mortgage. Delinquency increases debt and impacts credit scores. A good rule of thumb is to have enough in savings to cover 3-6 months of expenses. If that seems out of reach, start at $1,000.
Here are some easy ways to get started:
- Create a budget: Track monthly spending using a spreadsheet (or this free template from the Federal Trade Commission). Note any non-essential spending you can redirect towards savings.
- Pay yourself first: Use direct deposit to divert part of your paycheck to your savings account. Some banks let you schedule automatic transfers between accounts for free.
- Make your savings work for you: Transfer savings to a high-yield savings account. These generally have no minimum balance requirements.
Learn the best strategies for building and saving emergency funds.
Get Employer Match Money
If your employer offers a 401(k) match, don’t miss it. Contribute enough to meet their maximum match, so you don’t leave any free money on the table. You can’t take advantage of this offer retroactively. If you’re early in your career, compounded interest will make a huge difference in your retirement fund.
Don’t Forget Your Debt
Building savings doesn’t mean ignoring your debt. Continue making minimum payments on your debts until your emergency fund is full.
Pay Down High-Interest Debt
Once you have 3-6 months of emergency savings, focus on paying high-interest debts. The faster you pay down credit cards and payday or car title loans, the more you’ll save in interest.
If you’re tempted to work ahead and save in hopes of making money from interest, do the math. You’ll likely find you’ll pay more in interest on your debt than you’d make from interest in a savings account.
Save on interest and be debt-free faster
Use our debt payoff calculator to see if snowball or avalanche is the right method for you.
What About Mortgages and Student Loans?
You won’t get a lot of out paying more than the minimum on low-interest loans like mortgages and student loans. Yes, extra payments may save you money, but the lender won’t lower your monthly payments. It’s better to save these until you’ve cleared your high-interest debt.
Decide on a Repayment Strategy
Work with your budget to see how much money you can pay toward your debt. If you don’t already know how much debt you have, this is a good time to find out.
There are quite a few ways to pay down debt, including balance transfer credit cards. Many people have success with D.I.Y. methods like debt snowball or debt avalanche. Look into the pros and cons of different debt repayment methods to see which you prefer, and consider using a tool like a debt snowball calculator to see how that could work for your individual financial situation.
Don’t Forget Your Savings
As you pay back high-interest debt, be sure to maintain your emergency savings fund. Try to resist the urge to use it toward repaying debt. You never know when you may need to access savings.
Keep up The Balance
After paying off high-interest debt and establishing a financial safety net, keep going. This blended approach to savings and debt should continue to work. As your financial situation changes, revisit your budget. Create a new financial plan, adding more savings and repaying remaining debt.
Build Up Savings
Experts recommend having enough emergency savings to cover a year of expenses. Don’t let your emergency fund get too big, though, or you’ll lose out on other saving opportunities. Learn more.
If you’re only investing the minimum in your 401(k) to get your employer match, it’s an excellent time to bump this up. Your goal should be to invest 15% of your gross income for retirement.
Pay off Remaining Debt
Make a plan to pay off lower-interest debts, like student loans, car loans, and mortgages. With patience and the right tools, you can get out of debt quickly, even while saving for retirement.