Is Saving or Paying Down Debt Wiser?
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Sometimes it seems that falling into a deep hole of debt is incredibly easy, while climbing out of it is nearly impossible. Fortunately, it is completely possible to get your financial life back on track, but it will take extensive effort on your part. One of the earliest decisions you will need to make in this situation is whether you should focus your efforts on saving or on paying down your debt. The right answer, to some degree, will vary.
In many cases, credit cards and other types of debt will cost you far more in interest than you would be able to earn by saving your money. However, the decision is not always limited to simple mathematics. Other issues can also be a factor. Reasons for paying off your debt first can include eliminating high interest rates, improving credit scores and obtaining peace of mind. On the other hand, reasons for saving first could be that you have low interest credit cards or loans and you are more concerned with creating a financial cushion for safety and a form of insurance.
Your credit score, of course, is vital for many important purchases, such as cars and homes, and even for apartment rentals and job interviews in some cases. If you have the self-discipline to do so, maintaining a couple of credit card on which you make occasional purchases that you then immediately pay off can be a smart way to build your credit history. A small amount of debt that you do not let accumulate can actually help you in the long run.
Financial experts are like economists in that their advice varies widely and is often completely contradictory. When trying to decide if you should pay off your debt or put away your money for retirement you will likely find an equal number of financial advisors recommending each course of action. One thing that most would agree on, however, is that it is vital that you at least save up a small emergency fund as soon as possible to deal with unforeseen bills. Otherwise, you might find yourself sinking back into debt as fast as you climb out of it.
Since it is important to have a safety net – whichever overall financial strategy you choose – most advisors recommend that you set aside at least enough money to support yourself for at three to six months. This security net should be kept in a savings account or a money market account that can be quickly tapped in case of an emergency. Long term CDs and other less liquid investments that lock your money in for a set period of time and penalize you if you pull it out early are not recommended for your safety net.
Prioritizing interest rates is a fancy term for deciding when to save and when to pay off debts (and which to pay off first). Right now most banks only pay about 1.0 percent interest on certificates of deposit, while credit card companies are charging up to 21 percent interest on your debt. In this situation, of course, paying off your debt as soon as possible would be the right decision. Not only will this save you money over time, it will also help you maintain a good credit rating. It may sometimes be wise to carry a little lower-interest debt for tax or credit purposes, allowing you to save and invest the money you would otherwise put toward paying it down. In situations like this, you should rely on the guidance of a trained financial advisor to ensure that you make the right decision.
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