Is it better to repay debts or save?
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When you’re in debt with mounting interest charges, it can be easy to get tunnel vision. In many cases, paying off your debt should be your top priority. But being so focused on paying off debt can sometimes make it harder to achieve other important financial goals, like building an emergency savings fund to help cover unexpected expenses.
Whether it’s better to pay off debt or save depends on your particular financial situation. Here’s an overview of when you should prioritize saving over paying off your debt.
If you’re looking for a debt consolidation loan to help you manage your debt, visit Credible for quick and easy view your prequalified personal loan rates.
Repaying debts or saving: what should you prioritize?
The priority you should give to paying off debt or saving can depend on the type of debt you have and the interest rates on each. As tempting as it may be to spend any extra dollars you have on paying off debt, if you don’t have a rainy day fund in place, it could hamper your financial goals. If a costly emergency arises – like an unexpected medical or auto repair bill – and you don’t have an emergency fund in place, you may need to take on more debt to cover those unexpected expenses.
Generally, your first priority should be to save money for emergencies. If you have already saved some money, you can focus on paying off your debts until you are debt free.
If you have very high-interest debt or a type of debt that has hard-to-manage repayment terms (like a payday loan), you’ll want to pay off that debt first to avoid paying more interest. than necessary.
If you’re still struggling to decide whether to pay off your debt or build your emergency savings, see how much it will cost you each month. Take note of how much it costs you to pay off the debt and how quickly you can realistically pay it off.
HOW TO CREATE AN EMERGENCY FUND?
Reasons to pay off debt
It may make sense to pay off debt before saving in certain situations, including:
- You have a high interest rate. The faster you pay off your debt, the less interest you will pay. If you have high-interest debt, such as credit card debtyou can save a lot of money by focusing on paying off your debt before you save.
- You want to improve your credit score. The less debt you have, the lower your credit utilization ratio will be, which can improve your credit score.
- Debt causes you a lot of stress. As useful as an emergency fund is, if the thought of having debt is keeping you up at night and making your life extremely stressful, it may be a good idea to focus on paying down rather than saving.
Here’s an example of why paying off debt as quickly as possible can be a smart move.
Let’s say you owe $5,000 on a credit card with a 17% annual percentage rate, or APR. If you only make a minimum monthly payment of $121, it will take you five years to pay off the debt and you will pay a total of $2,573 in interest.
If you could double your monthly payments by paying $242 a month, you would pay off that credit card debt in two years and only pay $958 in interest. You can see how rushing to pay off your debt can make a huge difference financially.
If you have several high-interest debts that are weighing you down, you can consolidate these debts into one. debt consolidation loan, which is a type of unsecured personal loan. You will pay off your existing debt and then only have one monthly payment to manage. If you can get a lower interest rate with the new debt consolidation loan, you can pay off the debt even sooner.
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Reasons to save
As long as you’re still making the minimum payments on your existing debt, prioritizing savings also has some benefits that are worth considering. Here are some circumstances where saving before paying off debt might make more sense:
- You have no emergency savings. Running into a costly emergency can lead to increased debt, which can increase the amount of interest you’ll pay as well as the time it will take to get out of debt.
- You are working towards a specific financial goal. If you have an upcoming expense, like a vacation or a down payment for a car, focus on setting aside money to cover your financial goal so you don’t have to go into more debt to pay for it.
- You have a chance to earn compound interest. The money you save can earn you more money. When you put money in a savings account, certificate of deposit, money market account, or investment account, you may earn interest that accumulates and increases over time. The sooner you can start saving, the longer the interest has to accrue and the more money you can earn.
For example, let’s say you put $500 in a retirement account and invest $500 per month for five years with a return of 7.5%. If this interest were compounded annually, you would have $35,568 after five years.
Setting up an emergency fund
An emergency fund is an important safety net to have in case of unexpected costs. Here’s how to build one:
- Add up your living expenses. A good rule of thumb for an emergency fund is to save six months of living expenses. That way, if you lose your job, you can still afford the necessities. If you are employed and an emergency arises, this fund will likely be large enough to cover unexpected costs.
- Make a savings plan. Once you know how big you want your emergency fund to be, you can figure out how much you can afford to contribute to the fund each month. Add this amount to your monthly budget and stick to it as you would any necessary expense.
- Open a high interest savings account. Don’t leave your emergency fund savings in your checking account or regular savings account. Look for a high-interest savings account to open and store your emergency fund in so that the interest accrues and increases your savings for you.
Strategies for Repaying Debt
Many strategies are available to help you repay your debts. Here are some of the most common to consider:
- Use a balance transfer credit card or a debt consolidation loan. Combine your high-interest debt into one source, like a debt consolidation loanideally with a lower interest rate, can streamline your monthly payments and make it easier for you to focus on your debt repayment efforts.
- Work with a nonprofit credit counselor. You can book a free consultation via the National Credit Counseling Foundation and receive personalized advice on repaying your debts.
- Consider debt snowball or avalanche repayment methods. The debt avalanche method involves paying off your debt at the highest interest rate first (while making minimum payments on all your other debts), which will save you the most money on interests. With the debt snowball method, you first pay off your smallest balance, which can be more motivating since your balances disappear faster.
If a debt consolidation loan is the right debt repayment strategy for you, use Credible to view your prequalified personal loan rates and choose the loan option that best suits your needs.
Strategies to save
If you want to focus on saving, these strategies can help you get started:
- Create a budget. Setting a budget and sticking to it will help you stay accountable, avoid overspending, and develop better saving and spending habits.
- Reduce your biggest monthly expense. Although it may be difficult, see if you can reduce your most important monthly expenses. If it’s rent, you may be able to move to a less expensive apartment or find a roommate to help split the expenses. If your car rental is exorbitant, consider buying a used car when it ends. See what’s eating away at your budget and how you can save more.
- Negotiate your bills. Some bills, like cable and Wi-Fi, are more negotiable than you might think. See if you can negotiate better deals for all recurring monthly expenses, which will give you more money to save.
It’s possible to strive to pay down debt and save at the same time, but it’s important to plan ahead and develop a strategy that will benefit you.
For example, perhaps you can set a budget that includes both savings and debt repayment, such as contributing $300 toward debt repayment and $100 toward savings each month. As you pay off more of your debt, you can put more money into savings and get closer to achieving your financial goals.