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Key takeaways

  • Balancing debt repayment and saving is essential for achieving long-term financial stability..
  • Prioritize paying high-interest debts while maintaining an emergency fund for financial security.
  • Find a debt payment method and savings strategy that works for your financial situation. Being consistent is key.

Is it better to pay off debt or save?

Many Americans face this common financial dilemma. The answer, naturally, varies on a case-by-case basis, but generally it is both. It’s not as simple as either saving money or paying off debt. It’s a balancing act that, when done right, will help your finances for years to come.

Saving money will help you build an emergency fund and keep you from accumulating more debt next time unexpected expenses pop up. Paying off current debts will of course save you money in your interest payments and relieve financial stress.

Understanding the pros and cons of both approaches can help you make an informed decision about whether to pay off debt or keep money in savings and figure out how to strike your own balance.

Build emergency savings or pay off debt first?

Is it better to pay off debt or save first? Both are essential for financial security so how do you decide? There’s no one-size fits all answer. The key lies in striking a balance between the two.

Many financial experts recommend establishing a small emergency fund first and then prioritizing paying off debts. The amount of a safety net you need varies. Some experts say start with $500, while others want you to have three to six months’ worth of living expenses. Having a few months’ worth of living expenses ensures that when unexpected costs pop up, you won’t have to take out a loan or use your credit card.

On the other hand, if you have high interest debt – anything with an APR over 15% – then it’s good to pay them off as soon as possible. High interest rates will eat up your monthly budget and the debt can spiral out of control. Pay off high interest credit cards, payday loans, car title loans, and other high interest debt.

Learning how to save money and pay off debt simultaneously can lead to a more stable financial future.

Best ways to tackle debt

There are plenty of strategies on how to tackle debt so that you can put more money into savings. Some people ask if you should use savings to pay off debt. This is usually not recommended as you need savings to avoid borrowing in the future. Let’s go over a few other methods that can help you pay off what you owe efficiently.

Deal with high-interest and overdue debt

It’s a common misconception that debt is only when you owe money on credit cards, yet any borrowed money that requires repayment qualifies as debt. Certain debts, like credit card debt, are more important to pay off due to high interest rates. Others like mortgages, auto loans, and federal student loans have low interest rates and are less of a worry.

Interest on credit cards, payday loans, and other short-term loans can accumulate quickly if you’re not careful and spiral out of control. These should be your priority – possibly even over savings.

Try to make more than the minimum payment each month. Only paying the minimum amount will allow the interest to grow.

Overdue debts should also be a top priority. Delinquent accounts can negatively impact your credit score and lead to additional fees and interest charges. Contact your creditors to discuss potential payment plans or hardship programs. Proactively managing what you owe can help prevent further financial strain and improve your credit over time.

Are you thinking about debt management plans?

Read more about the pros and cons to see if it’s right for you.

Debt consolidation options

Debt consolidation is a popular strategy that helps you pay what you owe effectively and ideally for less. You consolidate multiple high interest debts into a single monthly payment. This simplifies your bills and ideally saves you money in interest.

There are several ways to do this:

  1. Personal Loan: Many banks and credit unions offer personal loans for debt consolidation. These loans typically have fixed interest rates and set repayment terms.
  2. Balance Transfer Credit Card: Some card issuers offer low or 0% introductory APR on balance transfers. Transferring high-interest balance to such a card can save you money on interest, but be sure to pay off the balance before the introductory period ends to avoid high interest rates.

Both methods may come with fees and require you to have good to excellent credit in order to secure a lower APR.

Research other debt repayment strategies

Debt consolidation is popular, but there are plenty of other repayment strategies and not all require having good credit. Look into the snowball method – pay off the smallest amounts first to build momentum and motivation – or the avalanche method – pay off high-interest bills first to save money.

Another possibility is a debt management plan (DMP) from a nonprofit credit counseling agency. DMPs provide a structured repayment plan with a set time frame. They can also lower your interest rate or waive fees, making monthly debt payments much more manageable.

Debt settlement is another possibility. This is when you or a debt settlement company negotiate with creditors to accept a lump sum payment that is less than what you owe.

Find a method that works best for your financial situation.

Benefits of paying off debt

pay off debts

Paying off debt, especially if it has high interest rates, offers numerous advantages.

  • Save money in interest
  • Lower credit utilization rate
  • Increase your credit score
  • Reduce stress

The primary benefit is, of course, that the more you reduce the amount you owe, the less interest you’ll accumulate and the more money you’ll have in your budget to save.

In addition to the benefits, it’s essential to acknowledge potential disadvantages of paying off debt too aggressively. For instance, not building an emergency fund or saving for retirement can leave you financially vulnerable. Next time an emergency hits you won’t have savings to cover it and will have to borrow again. It’s essential to balance the two for your overall financial health.

Read more about debt.

Setting up an emergency fund

When deciding between an emergency fund or paying off debt, many personal finance experts recommend saving first.

The first reason to save money is to build your fund, your emergency savings acts as a safety net for unexpected expenses. Medical emergencies, car repairs, or job loss can happen at any time. Having an emergency fund can prevent you from borrowing next time unforeseen costs arise.

You don’t have to start with a large amount. Ideally, you want to be able to cover three to six months of living expenses. Begin by saving a small, manageable portion of your income regularly. Set a goal of one months’ living expenses and work your way up from there.

Saving for retirement is still important

Paying off debt is important, but so is saving for the future. Building a retirement fund ensures long-term financial security. Starting early allows you to take advantage of compound interest which can significantly grow your savings over time.

Find out if your workplace retirement plan offers an employer match. A 401(k) matching contribution is essentially free money that can boost your retirement savings. Make sure to contribute the required amount to your 401(k) so you can take advantage of the extra cash.

Allocating a small percentage of your income to retirement contributions can establish a foundation for your future.

Strategies for saving

Building savings can be tough, but there are strategies to help you out. A few tried and true methods include:

  • Set a realistic goal
  • Try the 50/30/20 budget
  • Pay yourself first
  • Open a high yield savings account
piggy bank

Setting a realistic goal will help keep you motivated and not discouraged. Put what you can aside each month, even if it’s only $10. Don’t shoot for the stars at first. The key is to be consistent and to save. The compound interest of a high-yield savings account or retirement account will help your money grow.

The 50/30/20 budget is when you break your gross income down into categories.

  • 50% goes to basic expenses like housing, groceries, and utilities.
  • 30% goes to whatever you want.
  • 20% is put towards debt and savings.

This budgeting method ensures that you live within your means, have some fun money to spend as you like, and get to save. It’s an easy way to get started budgeting and saving.

Paying yourself first is when you put portion of your paycheck into savings as soon as you get it. Many employers will let you split your direct deposit so that you can send a percentage of your pay directly into your savings account. You never see the money, and so are never tempted to spend it. Automating your savings helps ensure that you consistently save a portion of your income without having to think about it.

Open a high yield savings account. High yield savings accounts offer a higher annual percentage yield (APY) than typical bank accounts. The higher APY will help your money grow faster with compound interest. A growing number of online banks offer high yield savings accounts with few fees.

Find a balance that works for your needs

When deciding whether it is better to build savings or pay off loans consider the interest rates compared to the returns on your savings. High-interest debts should typically be prioritized, as their cost can add up fast and outweigh the benefits of saving. However, ensuring you have a healthy emergency fund is also essential to avoid borrowing money in the future. Putting off retirement savings for too long also means that you will lose out on money through compound interest. It’s a lot to think about.

In the end, you have to strike a balance between the two. Pay your dues, but don’t forget to save money too.

Go to MoneyFor for more tips and tricks.

Frequently asked questions

Deciding if it’s better to have savings or pay off debt hinges on your individual financial situation. Prioritize high-interest bills to reduce long-term costs, but also build an emergency fund for unexpected expenses. Striking a balance ensures financial stability and peace of mind, helping you achieve both immediate and long-term financial goals.

Aim to save at least three to six months’ worth of living expenses in an emergency fund. This amount provides a safety net for unexpected costs like medical bills or job loss. Saving for retirement should not be overlooked. Ideally, you’ll put 15% of your income into savings. If you can’t manage 15%, start lower and build your way up.

Should you use savings to pay off credit card debt? Before deciding to use savings to pay off debt, consider the impact on your financial security. While it might seem logical to use extra money in your bank account to pay what you owe this can actually hurt you. Depleting savings entirely can leave you vulnerable to unexpected expenses causing you to borrow again. You also will lose the benefit of compound interest, that makes your money grow faster.

Bottom line

The eternal question of whether it’s better to pay off debt or save does not have an easy answer. You need to consider your full financial picture. Do you have lots of high interest debt? Do you have any money set aside in an emergency fund? Have you started saving for retirement? All these questions can be overwhelming. Take it one step at a time.

Start by repaying high interest debt and setting a small amount of money aside in a high yield savings account. As you reduce what you owe, put more money into savings. The idea is to strike a balance. Remember, saving money sets up a buffer so that you don’t have to take out a loan or use a credit card next time an emergency expense pops up, and they will pop up.

With a balanced approach, you can be debt-free with savings.

About the author

Rachel Alulis

Rachel Alulis has been the lead editor for Moneyfor’s credit cards team since 2015 and for the financial rewards team since 2023. Before joining Moneyfor, Rachel worked at USA Today and the Des Moines Register. She then established a successful freelance writing and editing business specializing in personal finance. Rachel holds a bachelor’s degree in journalism and an MBA.