What Comes First - Paying Debt or Saving?
If you’re trying to decide what’s right for you, use the following scenarios to help you decide:
Paying debt before saving
In general, if you have high interest debt that is not tax deductible, you should pay it off before saving. Here are a few examples to consider:
- Paying debt first makes sense because you’re getting a guaranteed “return” by cutting your interest payments. It’s typically more than you’ll earn in a savings account.
- Making extra payments on a traditional loan like a mortgage or student loan can save you a significant amount of money on interest in the long run.
- When deciding whether to pay off tax-deductible debt versus saving, don’t worry about losing a tax deduction if you pay off the debt. The deduction is probably worth less than the annual interest you would have paid on the loan.
Saving before paying debt
There are a number of good reasons to save first and pay later, but the number one reason is to build your emergency fund.
- If you don’t have any savings, focusing solely on paying debt can backfire when unexpected needs or costs come up. You might need to borrow again, and debt can become a revolving door.
- If your debt has a very low interest rate, it may make sense to save first. Start with $1,000 to $2,000 and build from there.
- It makes sense to save before paying debt when you’re talking about retirement savings, especially if there’s an employer match available. Try to at least contribute enough to your retirement plan to receive your employer match. That’s guaranteed free money.
Perhaps the best solution is to strike a balance between the two. Both improve your overall financial picture, which is the ultimate goal.