Should you get to work putting your hard-earned cash aside for the future? Or should you repay some of the money you already owe? Does one need to go before the other? How do you choose which is the priority? As with most other financial questions, the answers to these questions largely depend on the state of the rest of your financial affairs and your expectations for the future. Check out the key steps to help choose between saving money and paying debt.
1. Evaluate Your Current Standing
To get your bearings, it’s a good idea to first determine your current financial status. Record all the debts you pay monthly, from credit card and mortgage payments to student or personal loans. Write the amounts you owe and the interest rate you are paying. Also write down how much you have in your retirement, savings and investment vehicles and compare that to your goals. You can get a refresher of where you stand and this dose of reality alone can sometimes guide you to make the right decision for your situation.
2. Run the Numbers
Now, it’s time to evaluate not only can minimize your stress, but makes the most fiscal sense as well. It’s important to figure out how much your debt is actually costing you. This is a simple calculation where you multiply every item on your debt list by its interest rate. This is how much each loan is costing you per year. Then, figure out (or estimate) how much your savings can earn (don’t forget to include a 401(k) match if your employer offers one). Now check if the debt repayment can save you more than the money would earn in a savings account. If that is the case, you may want to focus more aggressively on paying off debt for now. If not, you can think about what works better for your comfort level and net worth.
If it’s a close call, you may be able to refinance your debt or consolidate it with a personal loan to help you make the decision easier. You’ll need a decent credit score (you can check your credit scores for free on Credit.com to see where you stand) in order to qualify for the best interest rates.
3. Find a Balance
Even if you prioritize one, it’s not a good idea to ignore either saving or debt repayment. They are both necessary parts of a healthy financial life that set you up for a financially secure future. You can create your own balance with a certain percentage of available funds toward debt service and the rest toward saving.
No matter what combination works best for your needs and abilities, it’s a good idea to make sure you can keep the commitment and have an emergency fund in place. This cushion is often the key difference in breaking the debt cycle, helping you avoid falling behind or further into debt as soon as you get into a financial pinch. Experts generally recommend three to nine months’ worth of income as an emergency fund, depending on job security and other sources of income.
Your final decision will likely require a balance of saving and paying off your debts.
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