Debt · June 12, 2020

Pay Off Debt or Save? The Answer Is to Do Both

Everyone has dreams or milestones they want to achieve—for you, maybe it's homeownership, starting a family or checking off that bucket-list trip to Europe. But while student loans or credit card debt still loom large, achieving those dreams can seem far-off.

Faced with these two seemingly competing goals, you've probably wondered, "Should I pay off debt or save for the future?"

We've got good news—you don't have to choose between the two. Here are some tips that will empower you to meet your debt obligations and still save some money for a rainy (or sunny) day.

Start an emergency fund

There's no time like the present to start an emergency fund—it'll give you the cash on hand you need to feel safe when life's curveballs come along.

Don't be afraid to start small. Just one or two months of living expenses is a great start. Depending on your situation, it may make sense to save four to six months of expenses—for example, if you're a high earner supporting a single-income family. 

Once you have your target amount tallied up, chart a savings path toward that goal. You could set up an automated savings plan where you contribute $25 a week or save a certain percentage of each paycheck. You'll also want to choose an account separate from your checking to keep and grow your savings.

Get an idea of your debt

Depending on your level of debt, payments to meet those obligations each month can take a decent chunk of your income.

You can better understand your current debt by using a debt versus savings calculator. Based on key factors, such as the interest rates on your existing debts, this tool can show you how much money you'll save in interest by putting extra toward your payments each month.

Set priorities

Is there a type of debt you should pay off first? You bet. There are three factors to consider:

1 Interest rates: Prioritize paying off debts with the highest interest rates.

2 Revolving debt: These are debts where your payment changes each month based on a fluctuating balance. They tend to have a greater impact on your credit score.

3 Fixed debt: This refers to debts paid back in installments toward a fixed total amount. This type of debt usually affects your credit score less than revolving debt.

Student and car loans typically have lower interest rates and are forms of fixed debt. Meanwhile, credit cards tend to be higher-interest and are revolving—so out of those three, you should prioritize paying off your credit card debts.

From there, you can use what's often called the snowball approach. Once you pay off higher-interest and revolving debts, you can shift those dollars toward your lower-rate debts.

Ways to save even more

Balance transfers can also help you save on interest and pay off debt faster. Look for credit cards with low introductory annual percentage rates (APRs, for short) and no balance transfer fees. You can also negotiate with your current card issuer and see if they have any offers available before transferring balances.

For student loans, you might consider refinancing with a private lender. In some instances, they may be able to offer a lower interest rate that could save you money in the long run. Before you look into refinancing, make sure you're not losing any federal benefits such as income-based repayment, which may not apply to your new private loan.

Avoid the excitement trap

It's easy to get motivated by watching your debt shrink each month. You could be tempted to put even more money toward your high-interest debts. Surely more is better, right?

It's OK to spend some money on a date night or a gym membership for the good of your mind and body. After all, your financial life isn't the only thing that's important to keep healthy. Just factor these expenses into your monthly budget. If you're consistent about hitting your savings and debt payment goals, you can still enjoy the things you love while setting yourself up for financial success. Plus, you'll feel better because you're actively achieving multiple goals.

Next steps

Over time, you can shift a portion of your monthly savings toward a dream fund. You'll feel more confident spending money on the things you want the most when you know your emergency fund is intact and your debts are on a solid payoff plan. Start by building that emergency fund, then continue growing your savings little by little while you pay off your debts, prioritizing high-interest, revolving debts and moving on fixed, lower-interest debts after that.

So, should you pay off debt or save money? Do both. Your future self will thank you.


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