Determining whether to prioritize paying off debt or saving depends on your unique financial situation: while eliminating debt quickly can help you avoid high interest payments, neglecting savings can cause you to miss out on potential opportunities for growth.
- Prioritize savings when you have low-interest debt, access to employer 401(k) match program, and a general lack of emergency savings
- Have at least three months of living expenses in your emergency fund
- Prioritize debt repayment when you have high-interest debt, and focus on your priority expenses
- Choose a debt repayment strategy—such as debt consolidation
- Set age-based savings goals to better track your progress
When deciding whether to save or pay off debt, you need to start by analyzing what kind of debt you have. Borrowers with high interest loans should focus on paying those down, while those with lower interest loans can concentrate on saving.
When To Prioritize Savings
There are some valid reasons for putting more of a focus on saving money. Here are some scenarios:
- Debt with a low interest rate: If you have credit card debt with a very low interest rate, it may make sense to save first.
- Access to an employer 401(k) match program: If you have a retirement savings plan through your job with an employer match, it’s best to contribute at least enough to get the maximum match. By not doing so, you’re essentially turning away free money.
- No emergency savings: We recommend building an emergency fund of three to six months’ worth of expenses and stashing it in a high-yield savings account.
Interested to know more on where to keep your money? Have a look at our guide on how to earn higher interest.
Savings Strategies For Growing Wealth
While you focus on cutting costs, it’s also important for you to build a culture of saving to help you prepare for rainy days. Here are some strategies that could help you out:
- Start small: If you are new to saving, it’s okay to start small—even if it’s only a few dollars per week.
- Save for retirement: Once you’ve built up your emergency fund, direct your savings efforts toward retirement. Aim to save at least 10%-15% of your annual pre-tax income for retirement, including any contributions from your employer.
- Automate your savings: Set up automatic transfers from your checking account to your savings account each month. This makes it easy to save money without having to think about it.
- Track your spending: Keep a detailed record of your expenses for a month or two to identify areas where you can cut back on spending and save more money.
- Use cashback apps: Download cashback apps that offer rewards for making purchases on everyday items like groceries or gas. There are also cash-back credit cards and browser extensions that are worth looking into.
- Cut unnecessary subscriptions: Take a look at all the subscription services you’re currently paying for and cancel those you don’t need or use regularly.
- Sell unwanted items: Sell items you no longer need or use on online marketplaces like eBay or Facebook Marketplace to earn extra cash.
How Much You Should Save
There are some general guidelines we can recommend when it comes to how much you should save. Once you have built up a solid emergency fund, the “50/30/20” rule can be a useful guide:
It’s a way to split up your take-home income into three buckets: 50% for necessities like rent and bills, 30% for things you want but don’t need (like dining out or shopping), and 20% for building up savings or paying off any debts you may have. It’s fairly straightforward to set up a savings account.
However, this rule may not work for everyone; especially those living paycheck to paycheck. It’s important to adjust based on personal circumstances.
Want to learn more? You may be interested in the alternatives to savings accounts.
When To Focus On Paying Off Debt
If you have debts with high interest rates, struggle to make minimum payments, or are finding it difficult to manage your debt, it’s time to focus on paying off debt.
This is crucial to avoid incurring more interest charges and potentially harming your credit score. There are several actions you can take to help with that.
No matter what kind of debt you have, you should always take advantage of a matching 401(k) program. Matching contributions from your employer are a source of free money that should always be taken advantage of.
Setting Up A Debt Repayment Plan
Consider creating a debt repayment plan to gain a clear understanding of your financial situation and prioritize your focus areas:
- Calculate your expendable income after paying for your needs.
- List all your debts, including revolving loans and installment loans, like a mortgage or a car loan, and their interest rates.
- Choose a debt repayment plan, like the snowball method, where you prioritize paying off smaller debts first, or the avalanche method, where you focus on paying off debts with the highest interest first.
- Create a budget that includes monthly debt repayments, and identify financial goals to add to your budget.
- Put extra money towards debt and save on interest with a balance transfer or personal loan.
Effective Strategies To Reduce Your Debt Quickly
Here are five proven strategies that can help you in paying off your debt:
- Use balance transfer offers: A balance transfer offer allows you to move your existing debt from one credit card to another with a lower interest rate, typically 0% for a promotional period. The conditions usually include a balance transfer fee, which is a percentage of the amount transferred, and a time limit to pay off the transferred balance before the interest rate increases.
- Consider debt consolidation: It allows you to combine multiple debts into one, often with a lower interest rate. This can make it easier to manage your debt and potentially save you money on interest.
- Negotiate with creditors: Contact your creditors and see if you can negotiate a lower interest rate or a repayment plan that works better for your financial situation.
- Increase your income: Look for ways to boost your income, such as taking on a side hustle or asking for a raise at work. Use any additional funds to pay down your debt faster.
- Seek professional help: A financial advisor or credit counselor can help you develop a customized plan for paying off your debt and managing your finances more effectively. Make sure to check their credentials before listening to their advice.
You should always try to lower the interest rate on your loans and credit cards, either by refinancing or using a 0% APR balance transfer offer. Doing so can make your debt repayment process more efficient.
Tired of your credit card debt? Check out if you can get rid of it using our credit card consolidation calculator.