Should You Pay Your Debt Before Saving?

Eight in 10 Americans are in debt and two out of three Americans wouldn’t be able to cover a $1,000 emergency if one presented itself. The solutions to these problems seem simple: pay your debt off and save your money; but which should be done first?

The answer to that question depends on what your long-term financial goals are and how prepared you are to begin paying and saving. There are a lot of factors that come into play when making the decision between paying off your debts and saving.

Emergency savings

Before settling on paying off your debt, you should make sure to have an emergency fund. Things like emergency car repairs, medical bills, last-minute trips, etc. happen. You need to have money set aside in case something happens. Don’t be discouraged if you don’t have an emergency savings account in place. Most Americans wouldn’t be able to cover a $1,000 emergency if they needed to; however, it is a good idea to have an emergency fund in place. If you are looking to pay off debt, be sure you have at least $1,000 in savings first.

How much debt do you have?

If you are wondering about paying off your debt, you should take a look at your debt as a whole. How much do you have? What lifestyle changes will you need to make to pay it off? How much is your debt costing you? Many credit cards and loans have a substantial amount of interest tacked on to it. Once you have emergency savings in place, you should begin to pay off your debt by level of importance. Credit cards and loans with higher interest rates should be paid off first. This will prevent you from throwing out a ton of money on interest.

Earnings on your savings

Another thing to keep in mind when you’re trying to decide whether you should pay off your debt or save first is how much you will earn from your savings. If the interest on your savings account is higher than the amount of money you are paying in APR on your debt, save first. This situation is highly unlikely though. Most banks and credit unions have seen a significant decrease in the amount of interest they are paying out on savings accounts.

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Check out your 401(k)

If the APR on your credit card isn’t high, you may want to look into a retirement savings plan or 401(k). Many employers match a certain amount of the employee’s contribution to the plan. If you’ve got your emergency savings set aside and no urgent, high-interest debt to pay off, you may want to see how much more money you need in your 401(k) to get your employer to match you. This is almost like having someone else save your money for you.

Financial goals

All in all, you should have a bottom line when it comes to your financial goals. If you are aiming to improve your credit score, you will want to pay off your debt before saving. If you want to improve your investment portfolio, you will want to put off paying off your debt and focus on your investments. If you have a goal for saving for something (i.e. a house, car, college, etc) and you don’t have any urgent debt, you will want to begin to save money by placing it in a high-interest savings account.

Making the decision about whether you should pay your debts or save first can be difficult. Keep your long-term financial goals in mind and take the road that will lead you to them.

Do you have a story about choosing to pay off debt or save first? Let us know. We’d love to hear from you!

Photo: Flickr: alamosbasement