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Save or Pay Off Debt: Which Should You Do First?

6 min read
save or pay off debt

Expenses and planning for the future is essential to your financial resilience and peace of mind. Yet, paying down debt can often feel like it should be your highest priority.

Which should you do first? It depends. Generally, it’s best to find a balance and do both at the same time if you can. Here are some ways to help you think about how to approach saving or paying off debt first.

Should You Save or Pay Off Debt First?

Balancing the competing goals of saving more money or paying down debt is a challenge many face. Ultimately, the approach you take will depend a lot on your current financial situation, your personal work-life circumstances, plus a little math.

For example, if your employer offers a matching 401(k) contribution, it’s a good idea to contribute up to the amount necessary to fully maximize that match. Doing so gives you a 100% return on your contribution up that threshold By simply making that contribution to your retirement account, you’re receiving a 100% return on that contribution. While you’ll also need to consider all aspects of your financial situation, this is a return on investment you don’t want to pass up.

Deciding whether to save or pay off debt is a balancing act, and this is just one example of how to think through it. Regardless of how you approach it, weighing your options and developing a strategy that makes sense to you can help you along your path to financial wellbeing.

When Should You Prioritize Saving?

Saving money for the future can make it easier to weather financial storms, avoid debt, and build wealth. Assuming you’re always meeting your minimum debt obligations, depending on your financial situation it might make sense to focus on your savings goals first (up to a certain point) before adding in any additional debt payoff strategy. Here are some examples of when prioritizing savings makes sense:

You don't have emergency savings.

With no money set aside for financial emergencies, any debt payoff strategy you may have put in place could be upset by even the smallest, unexpected expense. According to LendingClub research , the average emergency expense is about $1,400. And nearly half of consumers reported having had to pay at least one unexpected expense in the 90 days preceding the survey.

While you don’t have to wait until you have the recommended three to six months' worth of basic living expenses saved up before you start thinking about paying down debt—generally, it’s a good idea to put extra funds toward building your emergency savings first. Especially if you have zero dollars in emergency savings, the peace of mind and ability to avoid unexpected debt in the future can make it more worthwhile to save first and focus on paying off debt later.

Your employer matches your retirement contributions.

Your employer’s matching 401(k) contributions can have a significant impact on your ability to save for retirement.

For example, let’s say your employer offers a 6% 401(k) match. This means that your employer will match up to a total of 6% of your overall compensation to your 401(k) account on top of what you’re already contributing. Assuming you earn $75,000 per year and max out your 401(k) contributions, your employer’s match could be as much as $4,500. So, not taking advantage of this benefit is essentially the same as turning away free money.

Note that some employers don't vest their contributions immediately, meaning you would have to remain with the company for a certain period of time before the matching funds would be yours to keep.

Your debt is (relatively) inexpensive.

If most or all of your debt is at relatively lower interest rates, it may make sense to focus your attention on building your savings over paying down debt (or in addition to, if you can manage it).

For example, let’s say you want to pay down your auto loan faster by making additional payments to principal. However, if you’re earning an average annual return of 4.5% APY on your savings while your auto loan interest rate is only costing you 1.5% APR, in this case, prioritizing contributing more to savings versus paying off your auto loan at a faster clip would make more sense. As long as the return on your savings is available, it makes more sense to focus your attention there versus paying down the lower cost debt.

How to Start Building Savings

If you've decided to prioritize saving money, consider building an emergency fund first. That may be true even if you have an employer match on your retirement contributions, although making both retirement and emergency fund contributions are extremely important to your financial wellbeing.

While it may be true that skipping your employer match is like leaving money on the table, consider that if you need to withdraw from your retirement account in a financial emergency, you might have to pay penalties and taxes. Also, without an emergency fund, you might have to turn to expensive debt like credit cards and short-term loans to help make ends meet.

Once you’ve saved a small cushion in your emergency fund, you can start working toward maxing out your matching retirement contributions on the side. If you're not sure about your ability to do both simultaneously, consider creating a budget to find areas of spending where you could cut back on your expenses and save more.

When Should You Prioritize Debt Payoff?

While saving is a critical part of a healthy financial plan, high-interest debt can put a significant strain on your budget and your ability to save. Credit cards, payday loans, auto title loans, rent-to-own payments and other high-interest loans, in particular, can be extremely burdensome, both financially and psychologically.

Here are some situations when it makes sense to focus on paying off debt first.

You have zero room in your budget to save.

If your debt payments take up so much of your income every month that you don't have the ability to save money, it may make sense to look for ways to curb some expenses and earn extra income to build a small emergency fund, then start paying down your debt until you have a little more breathing room.

You're already (or at risk of) missing payments.

Missing a loan or credit card payment by 30 days or more can damage your credit score significantly , making it more difficult to get affordable financing in the future. To avoid getting caught in a vicious cycle of expensive debt, research ways to tackle your debt or to obtain relief—more on that in a minute.

You have a safety net.

If you already have three to six months of basic living expenses set aside and you're getting the full employer match on your retirement contributions, you may be in a strong enough position to focus on paying down debt without worrying about the impact of unexpected expenses.

How to Start Paying Off Debt

Depending on your circumstances, there are several different ways to approach paying off debt. If you can afford to put even a little extra toward debt payments every month (on top of making all of your minimum payments), the debt snowball method or debt avalanche method can help you accelerate your debt payoff by focusing on your lowest balances or highest interest rate cards first.

If your credit is in good shape, you may consider a debt consolidation loan or a balance transfer credit card to simplify your monthly payments. These could help you pay down debt more quickly and possibly save you money on interest with a lower APR.

That said, if you're at risk of falling behind on debt payments, consider consulting a credit counselor, who can provide personalized advice and potentially set you up on a debt management plan, which may offer you some relief on interest and monthly payments.

Finding a Balance Between Building Savings and Paying Off Debt

Based on your circumstances, you may choose to either build your savings or pay down debt first, at least in the short term. But in the long run, it's prudent to search for a balance between the two. Here are some strategies to consider:

  • Stick to a budget:

    Knowing where your money is going every month can make it easier to allocate money toward your financial goals. In addition to setting monthly goals for expenses, savings and debt payments, monitor your expenses to ensure you stay on track.

  • Consider debt consolidation:

    If your credit is in good shape, debt consolidation can potentially reduce your monthly debt payments, freeing up some cash you could put toward building your emergency fund or other savings goals.

  • Focus on eliminating toxic debt:

    High-interest debt poses a great risk to your ability to both save and pay off debt, so it's crucial to prioritize paying down those balances as early as possible in the process.

  • Increase your income:

    Look for opportunities to earn more money based on the amount of time you have available. This may include working overtime hours, adding a second job, looking for a higher-paying job, or starting a side hustle. The more money you earn, the more effective you can be with your goals.

The Bottom Line

Is it better to save or pay off debt first? Ultimately, the right approach depends on your financial situation and goals. As you use these tips and strategies to navigate your personal circumstance, try to seek a balance between building and maintaining sufficient savings while at the same time paying off high-interest debt that can, ultimately, end up holding you back.

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