Should I Save Money or Pay Off my Debt First?

Dealing with a large debt load can feel like an impossible situation. Whether student debt, credit cards or even your mortgage, the financial pressure that debt creates can cause severe stress. Each month, as you scramble to make your monthly payments, you may feel anxious and worried about how you can get out of this financial mess.

Often the first question you must answer is whether you will pay off your debt first or build your savings. Both ideas have merit, so here is a closer look at the choices to help you make a wise decision.

Advantages of Paying Off Debt First

Paying off your debt first, then focusing on your savings, carries several advantages. Lower debt-to-income ratios have a direct impact on your credit rating, and paying off your debt frees up funds to use for savings.

For example, if you can pay off your mortgage early, you will release a significant amount of money in your monthly budget to put towards savings. The same is true for paying off other types of debt as well, through debt consolidation.

If your main source of debt stress comes from credit cards, then paying off debt first saves you a significant amount of money in interest. In 2018, the average credit card interest rate hit a record high of 16.71%, USA Today reports. In 2017, the average credit card balance was $6,354. Paying just the minimum on a debt that fits this profile means you will spend five years and four months paying it off, adding up to $3,246.25 in interest charges, according to David Weliver of Money Under 30. Credit card debt is expensive, and paying it off sooner protects you from those costs.

Benefits of Saving First

Paying off debt first may feel like the right move when you are facing a serious debt problem, but it may not always be the wisest. If you are funneling all of your extra funds into your debt, and you face an emergency like a flooded basement or major car repair, you will have no choice but to take on more debt to cover it. If you save first and build up an emergency fund, you will have money to draw from to pay for those unexpected expenses, protecting you from adding to your debt problem.

Saving also helps you build your credit scoring range. According to Experian, your savings accounts do not have a direct impact on your credit rating, but they can have an indirect effect. First, it gives you that buffer to avoid driving up your credit card bills. Second, it provides reserves if you ever face a month when you cannot make your minimum debt payments. It protects your credit by preventing late payments, which will pull down your score. Third, a savings account improves your credit eligibility for certain types of lenders, such as mortgage lenders.

Is It Possible to Save Money and Pay Debt at the Same Time?

With benefits associated with either, you may be wondering if you can do both at the same time. Well, of course it is possible in some instances.

Let’s say you have a married couple who both are employed. The couple has extra money that they want to allocate to either debt or savings.  Depending on the amount, the couple can do both. If they have $200 extra, then they could allocate $100 to savings and the remaining $100 to paying down debt. It may take longer to build up the emergency fund and/or pay down debt but by working on both, the couple should not have to take on more debt in the event of an emergency (or at least less debt due to the savings). Another option would be to build up the emergency fund first and then aggressively pay down their debts.

Paying down debt and saving at the same time requires focus, planning, and careful budgeting, but it is possible to do according to Erik Folgate of Money Crashers. The success of paying down debt and saving at the same time varies case-by-case depending on the unique financial position of each family or individual.

Apps and Other Digital Tools to Calculate Saving or Debt Paying Capacity

Planning for debt repayment and savings starts with understanding what you can afford to put towards your debt and your savings plan. Here are a few tools that can help you:

• Free online debt or savings calculators — Online calculators, like this financial calculator from Nerd Wallet, Debt Snowball Calculator, which helps you plan your budget, savings, and debt repayment. These are helpful because they give you instant information about your debt, such as the total amount you’ll be paying in interest, the length of time you will need to repay your debt, and how long it will take to achieve your desired savings level.
• Excel spreadsheets — If you are knowledgeable about working in Excel, Microsoft offers some functions that will help you figure out how to pay down your debt quickly. Spreadsheets are helpful because you can save your information to come back to later, unlike free online calculators.
• Spendebt — This is a repayment tool that helps you automatically pay down your debt with every transaction you make. A predefined amount is added to every transaction, placed in a savings account and then sent as payment to your creditor every month. If you continue making your minimum payments and add this app to the equation, you will start paying down your debt quickly.

Learn more about your options in our How-to Super Guide to Pay Off Debt.

Getting Control of Your Finances It’s Worthwhile

Paying down debt first has merits, and so is establishing an emergency fund or savings account. If you are ready to take control of your finances, you may be able to do both with planning and discipline.

Once you have your debt and initial savings under control and learn how to be disciplined with your money, you will be able to focus on additional financial goals, like investing.