Should You Save Money Or Pay Off Debt?
There is a fine balance between the advantages and disadvantages of paying off your debt or saving your money, with some important factors to consider. Ultimately, you are looking to your retirement age and making sure that you could make the best of that time, with the ability to live well and free of financial stress. Ideally, we would all want to enter retirement free of any debts, but paying off your debts now means to potentially have to sacrifice sufficient retirement savings. So how do you choose where to best direct your money?
Ideally, you should conduct a blended approach and attack both goals on a smaller scale. Save some of your earnings, while using others to pay off debts. You will be able to assess your optimal approach after understanding some of the pros and cons of saving more money or paying off more debt first. You can then reassess your financial plan situation and adjust your savings to debt-repayment ratio accordingly.
Paying Debt And Skipping Savings
The downside of paying off your debt without putting anything towards savings is that if you have a financial emergency, you will only have your credit cards to fall back. This will only add on to your debt, potentially to a significant degree, depending on your financial emergency. It is a good idea to plan your finances with the assumption that a financial emergency will arise, even if one does not actually manifest.
When To Prioritize Debt Payment
When your credit cards have high-interest rates, it is wise to focus on repaying debts first before putting money off to savings. With fixed-payment loans, such as mortgages and student loans, making extra payments will reduce the longevity of the loan, as any extra money will go towards the principle of the loan, as long as you indicate this specifically. Otherwise, this extra amount will just be applied to a future payment, rather than reducing your outstanding balance. This means chopping off payments from the end of your loan, and not cutting down the current monthly payments will get lower.
If your concern is that by paying off fixed-payment type loans faster will affect you getting a tax deduction, its important to remember that the deduction will likely be a smaller amount than that of the interest you have paid for the year on your loan.
Saving Without Paying Down Debt
Prioritizing saving money over paying down debt comes with its own set of drawbacks. If you put paying off credit cards on the backburner, their interest rates, which are typically higher than the interest rate you will earn from putting money in savings, will actually cost you money because of the interest spending outweighing what you earn on your interest from savings.
Another issue with taking this approach is that you will likely enter retirement in debt. If your retirement saving money is what you will depend on to live, you will have a hard time living a comfortable lifestyle if you are burdened with paying off the remaining debt. This could either force you to have to get back to work during retirement or live on a very strict budget until the debt is paid off.
When To Prioritize Savings
If you are fortunate enough to have all debts with low-interest rates, putting most of your money into savings makes more sense while the debt interests remain low. This way you can achieve filling up your or emergency fund, and then turn back to repaying your debt. An emergency fund ideally should be able to cover 3 to 6 months of living expenses. If this is a challenge, you can focus on building and maintaining a $1000 fund. This will be enough to cover smaller scale emergencies like car repair and unexpected small scale health-related payments (dentist bills for instance).
If you focus on paying off debts for too long before starting to save for your retirement, you are doing so at the expense of allowing more time for your savings to grow. The longer you wait to start, the more money you will have to dump into savings in order to have a sufficient amount in there by the time your retirement goal is reached. However, if you start earlier, and save your money in an interest yielding account, you will have years of extra time within which you grow your interest, and obtaining extra from savings.
The Best Approach
The ideal approach is to find a happy medium between doing both. Putting off either one is not a good idea, so devising a way to contribute your earnings to both is the best strategy. If you have an extra $1000 per month, for example, try putting half to savings and half to paying off debt. While you would pay more in interest with small scale debt payments, you will have the peace of mind that you are saving money for your future and your retirement.