Should you pay off your debts before saving?
2020 has turned out to be a difficult year in more ways than one.
the Coronavirus pandemic in particular has brought to light the many economic disparities in America and left millions of Americans struggling to make ends meet. Many found themselves dipping into their emergency savings – or worse, wishing they had some.
On top of that, 34% of millennial credit card holders said they had taken on even more debt as a direct result of the pandemic, according to a May survey on CreditCards.com, a sister site of Bankrate.
Juggling debt and worrying about building up savings at the same time can really take a toll on a person. While there isn’t one right answer for everyone, here are scenarios where each choice – paying off debt or saving – makes more sense.
When to make backup the priority
There are a number of good reasons to save first and pay off debt later.
Some of the main reasons include:
- Debt with a very low interest rate
- Access to a 401 (k) employer matchmaking program
- No emergency savings
If you have a credit card or other debt with a very low interest rate, it may be a good idea to save first, says Melissa Joy, Certified Financial Planner and Founder of Pearl Planning, a financial planning practice and manager in Dexter, Michigan.
Another situation where it makes sense to save before paying off debt is if you have access to a retirement savings plan by your work, especially if there is a correspondence with employer available. Try to contribute at least enough to get as many employers as possible. If you don’t, you are effectively hijacking free money.
And putting off saving for retirement until you’re debt free could cost you your most valuable asset – time. With compound interest, even small contributions to your pension plan can increase dramatically.
However, the main reason for making savings a top priority over debt repayment is to build your emergency fund. Without some money saved, you might just end up adding to your credit card debt to pay for an unscheduled car repair or a trip to the emergency room.
“If you don’t have savings, focusing only on paying off your debts can backfire when unforeseen needs or costs arise,” says Joy. “You might need to borrow again, and the debt can become a revolving door. “
What could possibly go wrong? Well a lot of things, especially now. The importance of this fund was highlighted in the coronavirus era: 23% of Americans said their biggest financial regret during this pandemic did not have enough emergency savings to overcome the crisis in a June Bankrate survey.
Saving first – and building a decent emergency fund – could be the difference between going through tough times and ending up in bankruptcy court.
How much to save
Experts recommend build up an emergency fund spending three to six months and putting them in a savings account. Some even recommend putting enough money in the bank to be able to pay your expenses for an entire year.
But you have to start somewhere. Aaron Graham, a CFP with Abacus Planning Group, Inc. in Columbia, SC, suggests starting out first with a goal of covering expenses for just one month.
“There is no excuse not to save for these emergencies,” says Graham. “It’s not about whether they will happen, but when; plan accordingly.
While you’re at it, shop around the different banks to get the best possible rate on your savings.
Saving in the Age of Coronavirus
For those fortunate enough to still have an income and the ability to work from home, this could be a good time to build up your savings.
“Now that Americans are spending more time at home, they should be thinking about their new ways. Take a look at cell phone and cable bills and ask yourself if you need to adjust your plan to avoid overage charges, ”says Lindsay Sacknoff, head of consumer deposits, products and payments at TD Bank. “There may also be bonus services that you have already paid for that can be reconsidered now that you have more time at home, like a house cleaning service or a babysitter. These expenses can now be removed from your budget so that you can save that extra money.
On the other hand, if you are facing reduced income, you may want to contact your lenders and suppliers to discuss temporary payment relief options.
“It can be easy to assume that the amount that shows up on your monthly bill is set in stone, and for some municipal utilities like water and electricity it can be,” says Tony Wahl, expert in credit and loan at Credit Sesame in Mountain. See, California. “However, subscription services like telephone, cable and Internet can sometimes be negotiated. This can help you prioritize your bills and free up some of your available money to add to your savings.
Interest rates are very low right now, which usually means two things: people don’t have as much incentive to save, but they have more of an incentive to buy or get a loan. However, you shouldn’t let these low rates discourage you from saving, because if there’s one thing we’ve learned from coronavirus crisisis that hard times come when you least expect them – prepare now for that next emergency.
When to prioritize debt repayment
When you have high interest consumer debt, paying it off first can help you resolve lingering issues with managing your money.
You will get a guaranteed return by reducing your interest payments. This is usually more than what you would earn on the stock market and certainly more than what you would earn in a savings account.
To start paying off your debt, here are four things to consider:
- Calculate your disposable income (what’s left after taxes, bills and food)
- List all your regular expenses (even if they are recurring) and see if there is anything you can eliminate
- Create a budget based on that number and include paying down debt as an important part of the equation
It also helps identify what your financial goals are, so you can prioritize them within your budget. In this case, we assume that paying down the debt is your number one priority. By putting a monthly repayment into your budget, you will better ensure that you still have cash for necessities.
Another option to consider is a credit card balance transfer. This can allow you to consolidate all of your credit card debt into one low rate card and save you money on finance charges.
Tara Alderete, director of education and community at Money Management International, says it generally makes sense to prioritize debt reduction, but there are exceptions.
“If you already have enough savings in your emergency fund, you might want to focus on getting rid of debt quickly,” says Alderete. “However, if you only make minimum payments on extremely high interest rate debt, those debts can cause you to lose money and prevent you from reaching your overall financial goals, and you might want to focus on reimbursing these costly expenses. debt.”
According to Alderete, an important part of budgeting is focusing on your priority spending first, so that you can free up some money to spend on a debt reduction plan while hopefully. the, still able to contribute to an emergency fund.
When deciding whether to pay tax deductible debt compared to savings, 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.
The ideal approach
The best solution might be to find a balance between economy and pay off the debt.
You may be paying more interest than you should, but having savings to cover sudden expenses will save you from the debt cycle.
Plus, having enough savings provides peace of mind. Some people are unlikely to feel comfortable with a strategy that drops their savings below a certain level. For them, saving and paying off debt at the same time may be the best approach.
“Every savings versus debt situation is on a case-by-case basis,” says Aaron Clarke, wealth advisor at Halpern Financial in Ashburn, Virginia. pay off debt and save at the same time.