Save Money or Defeat Debt
When it comes to personal finance, one of the most common dilemmas is about deciding between saving money or paying off debt. Both goals are essential for financial wellness, but which should take priority? Truthfully there is no one straight answer. The reality is that it depends on your individual financial situation. In this blog, we’ll break down the pros and cons of saving versus paying off debt, offer tips to evaluate your unique situation, and provide practical strategies to achieve financial wellness.
Saving Money is Essential
Saving money provides a sense of financial security and opens the door to opportunities. Here’s why prioritizing savings might make sense for you:
- Emergency Preparedness - Life is unpredictable. An emergency fund acts as a financial safety net for unexpected expenses, such as car repairs, medical bills, or job loss. Experts typically recommend saving three to six months of living expenses. That said, a survey from the Federal Reserve found that 37% of Americans wouldn't be able to cover an unexpected $400 expense without selling a personal item or borrowing money.
- Avoiding New Debt - Without savings, unexpected expenses often lead to more debt. For example, a broken appliance, car repair, or an unplanned medical payment could result in a credit card charge that adds to your financial stress and lasts for years.
- Taking Advantage of Opportunities - Saving money allows you to seize opportunities, like investing in education, building a down payment for a new rental, or starting a business.
- Peace of Mind - Having savings can reduce financial anxiety, making it easier to focus on long-term goals instead of just surviving month to month.
However, savings accounts often earn low interest, especially compared to the high interest rates on many debts. This is where debt repayment comes into focus.
The Case for Destroying Debt
Debt, particularly high-interest debt like credit cards, can be a significant barrier to financial success. Here’s why paying it off may be your top priority:
- Reducing Interest Payments - High-interest debt grows rapidly, making it harder to escape over time. Paying off debt early reduces the amount of interest you’ll pay overall, saving you money in the long run. You can also effectively reduce interest payments by consolidating debt which you can read about here.
- Improving Cash Flow - Every dollar you pay toward interest is a dollar that can’t go toward savings or other financial goals. Eliminating debt frees up your cash flow, giving you more flexibility.
- Boosting Your Credit Score - Lowering your debt-to-income ratio and reducing outstanding balances can improve your credit score. This makes it easier to qualify for loans and get better interest rates in the future.
- Reducing Financial Stress - Debt can weigh heavily on your mental and emotional well-being. Paying it off can provide a sense of relief and accomplishment. This relief is similar to the positive benefits towards our physical, mental, and social health associated with budgeting which you can read more about here.
But while paying off debt is critical, putting all your focus on debt repayment without any savings can leave you vulnerable to financial setbacks.
How to Choose: Savings or Debt Repayment?
The best approach depends on your specific financial situation. Here are a few factors to consider:
1. Do You Have an Emergency Fund?
If you don’t have at least $500–$1,000 saved for emergencies, prioritize building this fund before aggressively tackling debt. Even a small cushion can prevent you from relying on credit cards when unexpected expenses arise.
If you don’t have at least $500–$1,000 saved for emergencies, prioritize building this fund before aggressively tackling debt. Even a small cushion can prevent you from relying on credit cards when unexpected expenses arise.
2. What Are Your Debt Interest Rates?
High-interest debt, such as credit cards with rates above 15–20%, should take priority after establishing an emergency fund. For lower-interest debt, such as student loans or mortgages, you might balance repayment with savings.
High-interest debt, such as credit cards with rates above 15–20%, should take priority after establishing an emergency fund. For lower-interest debt, such as student loans or mortgages, you might balance repayment with savings.
3. What Are Your Goals?
If your goals include buying a home, starting a family, or pursuing further education, you may want to prioritize savings while still making minimum debt payments.
4. How Stable Is Your Income?
If your income is steady and reliable, you may feel comfortable focusing more on debt repayment. If your income is variable, prioritizing savings might be a better strategy to buffer against fluctuations.
5. Are You Eligible for Matching Contributions?
If your employer offers a 401(k) match or similar program, take advantage of it. Contributing enough to receive the full match is essentially free money and should be prioritized alongside other financial goals.
Finding the Right Balance
For many people, the best strategy is a combination of saving and debt repayment. Here are some actionable steps to help you balance these priorities:
1. Start with an Emergency Fund
Save at least $1,000 to handle unexpected expenses. This is your first line of defense against accumulating more debt.
2. Pay Off High-Interest Debt First
Focus on paying off debts with the highest interest rates while continuing to make minimum payments on other debts. This approach, known as the avalanche method, saves you the most money on interest.
3. Save Small Amounts Simultaneously
While aggressively paying off debt, set aside a small portion of your income—such as 5–10%—for savings. Even small contributions add up over time.
4. Automate Payments and Savings
Automating your savings and debt payments ensures consistency. Set up automatic transfers to your savings account and schedule regular payments for your debts.
5. Reevaluate Regularly
Financial situations change over time. Reassess your goals and adjust your strategy as needed. For example, once high-interest debt is paid off, redirect those payments toward your savings.
How Your Credit Union Can Help
As a member-focused financial institution, we’re here to support you every step of the way. Here’s how we can help:
- Savings Accounts - Open a savings account with no monthly fees to start building your emergency fund. Consider options like a high-yield savings account or money market account to earn more on your deposits.
- Debt Consolidation Loans - If you’re struggling with high-interest debt, consider a debt consolidation loan. Consolidating debt at a lower interest rate can simplify your payments and save you money on interest.
- Financial Coaching - Our certified financial counselors can help you create a personalized plan to balance saving and debt repayment based on your unique situation.
- Budgeting Tools - Use our online budgeting tools or mobile app to track your progress. Setting and monitoring goals is key to achieving financial success.
- Educational Resources - Access our webinars, blogs, and workshops to learn more about managing your finances effectively. We’re here to empower you with the knowledge you need to succeed.
The Bottom Line
Choosing between saving money and paying off debt doesn’t have to be an either-or decision. By finding the right balance, you can build a secure financial foundation while working toward a debt-free future. Start with an emergency fund, tackle high-interest debt, and save consistently, even in small amounts.