Is it better to pay off debt or save?

Choosing whether it is better to pay off debt or save can be a difficult choice as they are both important, but it may make more sense to pay off your debt, like loans and credit cards, before you start saving. That’s because you’ll typically be paying more interest on your debt than you would earn from interest on your savings.

Of course, it’s always best to check these figures as everyone’s financial situation is unique, but if you are paying more in interest on your debt than you could earn from growing your savings, you might be worse off if you start saving before paying off your debt. This is especially the case when the debt you have is very high interest, which is often the case with credit card debt.

Deciding what money is for saving and which is for paying off debt requires prioritizing debt payments. It’s usually best to first pay off debts that charge higher interest rates, such as credit cards and store cards, as this is the type of debt that will cost you the most.

After that, you can move on to less “expensive” debts which charge a lower interest rate, but be wary of waiting to pay off debts with promotional rates that may have an expiry date, as these debts may soon turn into your most costly debt. Paying off your most expensive debts first can help you reduce your total costs as you’re not letting the interest you owe grow over time.

Once again, not all debts are created equal. Prioritizing debts with higher interest rates can help with your longer term financial strategy and potentially save you in the long run.

Consider your mortgage, for instance. You may not consider your mortgage to be a debt, but it is. And like any debt, the sooner you pay it off, the sooner you’ll have full control of your own finances. Your mortgage is different to other debts because it is much less flexible and usually has a lower interest rate. 

So, should you pay off this debt with savings? If you can use your savings to help reduce or clear your mortgage, this can bring many benefits. Paying off your mortgage early, for example by switching to biweekly payments if possible, can be a faster route to financial security and freedom, and also means you’ll have reduced monthly outgoings. 

You may want to balance saving and paying off debt. It’s also a good idea to keep some money in reserve, like an emergency fund, should the unexpected happen, so you may want to make sure you have some funds available just in case.

If you want to pay off debt and save at the same time, there are a few things to consider. As we mentioned earlier, it’s probably best to pay off your most expensive debt first, like credit cards or store cards. You might also want to compare different types of savings accounts to ensure that you earn a competitive rate of interest and can grow your savings pot. The savings accounts which offer the most competitive interest rates are typically the following:

High-yield savings accounts feature competitive variable interest rates and the flexibility to withdraw your savings when needed. You can open a high-yield savings account with a single lump sum deposit, and keep your account open for as long as you want. You can also add to your savings with additional deposits whenever you want. Even if you start with small, regular deposits each month, it will add up quickly over time to create a solid emergency fund.

If you have a lump sum that you’re happy to lock away for a fixed time period at a rate that won’t change from the day you open your account until it matures, certificates of deposit might be the right type of savings account for you. CDs are a risk-free way to grow your savings, and they usually offer more competitive interest rates than savings accounts that allow you to dip in and out.

A money market account is a type of interest-earning savings account. Money market accounts provide many of the conveniences of a typical savings account but with a major added benefit — they often have higher rates than checking or savings accounts. Some financial institutions set limits on how often you can withdraw funds from their money market accounts or have high minimum deposit requirements.

If you have an emergency fund or you’re building one as a safeguard against unforeseen future expenses, you may have considered paying off your debt with this fund. This is, of course, a personal choice and not one that you should make without considering all of your options first. You might want to think about the following if you’re considering paying off your debt with your emergency fund:

• If you don’t use your emergency fund, will you incur more debt than you’re able to cope with?
• Do you want your emergency fund to remain intact so you can access it if you need to?
• Could you grow your emergency fund while paying off your debt?
• Is paying off your debt the kind of emergency that your emergency fund is meant for?
• If you use your emergency fund to pay off your debt, how quickly could you build it back up afterwards?

While you might decide that a portion of your emergency funds could be used to pay down high-interest debt, it may be a good idea to reserve some of this nest egg so you are not caught off-guard in a true emergency so you aren’t put into a worse situation by relying on high-interest loans. It may be more prudent to prioritize both paying down high interest debt while maintaining and slowly building your emergency fund.

The fact that one in five Americans don’t think they’ll ever be able to afford to retire shows how important it is to be debt-free and have savings when you reach retirement age. After all, this is your reward for years of hard work and the chance to do the things you’ve never had time for.

While it’s important to start saving for retirement as early as possible, paying off any debt you have first could enable you to save for your retirement more effectively. You might not want to dig into your retirement savings to pay off debt.

Understanding whether it is better to pay off debt or save during a recession comes down to your personal finances. Generally speaking, however, even during recessions it remains important to prioritize debts with higher interest rates, like credit cards or store cards, while continuing to save for retirement, emergencies, and other needs.

Deciding between paying down debt or investing requires understanding the interest rate or rates on your debt and your potential earnings on investments. For instance, if you can earn a return greater than 5% on high-yield savings accounts or certificates of deposit, but you have a mortgage with an interest rate around 3%, then investing that money may make more financial sense than paying off the debt.

In contrast, if you’re looking at credit card debt charging 25%, the calculus shifts. It may make more sense to pay down debt vs. investing in this scenario.

If you decide to pay off your debt before you start saving, it’s important to have a plan that you’ll stick to. This may help you consistently pay off your debt (it might even help you pay it off quicker) and get on top of your finances. Try putting together a budget where you can record and track your monthly income and expenditures, and identify where you can cut back on spending to pay off your debt.

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The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.