Is it Better to Save Money or Pay off Your Debt?
If you’re fortunate enough to have an income that exceeds your bills, it can be confusing to figure out how to put that positive cash flow to good use. Is it better to pay off your debt or put it into savings?
Deciding whether to save or pay off debt can be determined by examining a few important factors. Making an informed decision can have a profound effect on your finances.
Ask yourself these questions to determine how best to utilize your extra cash:
1. Do I have an emergency fund? Putting away some money is a good first step if you don’t have any savings. Even with high-interest debt, creating an emergency account before attacking your debt will provide greater financial stability because you won’t be reaching for that credit card in an emergency, adding even more to your debt. You’ll sleep better at night, too.
Saving 3-6 months’ worth of expenses is enough for most people.
2. How risky is my source of income? Have you worked for the same company for 15+ years and expect to work for 15 more? Or is your company or job less secure or your income variable?
A stable income would tend to favor paying down debt, whereas less stable employment tips the scales in favor of saving in case of a job loss. With an unstable job situation, 6 month to 1 year of living expenses in an emergency fund is a safer bet.
3. What is the interest rate on my debt? Your credit card interest rate might be 19% or more. If your 3-6 month emergency fund were in place, it would make sense to pay on your high-interest debt. Paying on a 15% debt is similar to earning a 15% return.
4. What are my financial goals? If you’re nearing retirement and already have plenty of money set aside, get busy eliminating your debt! However, saving might be a more reasonable option if you’re sending your child to college next year.
· What are your goals and how will this decision impact them?
5. What’s most important to me? Think about which option puts your mind at ease. For some of us, having a good cushion in the bank adds a feeling of security, instead of that “living in the edge” feeling of waiting for the next event that Murphy throws your way. For others, being debt-free feels better. Avoid ignoring the emotions surrounding your financial decisions.
Being comfortable with your finances is important.
Paying down debt and saving are both worthwhile options for your extra cash. Either choice is better than spending it! The option that’s better for you will depend on your individual circumstances. Once you’ve got a starter emergency fund of one month of necessary expenses, you could consider doing both simultaneously. Save a little and apply a little toward your debt. For many people, this can be the best of both worlds.