Inflation Cents

Should I Pay Off All My Debt Before Saving?

should I pay off all my debt

Paying off high-interest debt can be overwhelming and sometimes interfere with your savings. So, you might ask yourself: “should I pay off all my debt and shift my savings till later or build my savings and focus on debt repayment later?”

The goal is to find a balance where you have money stashed somewhere and are comfortably paying off your debt. A couple of strategies will help you win on both ends- paying off your debt and building your savings. 

Making these monthly payments may feel like a Herculean task, as it may always look like you’re always running short of money for regular expenses. Most credit card companies charge as much as 30% interest on outstanding balances, while most savings accounts earn only about 1% interest. So, sometimes, paying off debts immediately after income enters your account may be best, especially if you have high-interest debts.

Try using a financial calculator to understand how long it would take to pay off your debts. You can also use tools to check the benefits of topping your payments. There is a remarkable difference in general cost and the time between the payment of the minimum amount each month to place your account in the right standing versus paying a fixed minimum amount each month.

Paying Off Debt Improves Your Credit Score

One very good reason to prioritize debt payment is that it improves your credit score and chances of qualifying for things like a car loan or mortgage. While a hefty savings account doesn’t influence your credit scores like credit card and loan balances, savings are considered when you apply for a loan.

By paying down your debts, you show that you’re credible, which makes you eligible for lower rates on mortgages and loans. Clearing off your credit card balance down to 75% of your credit card limit will significantly improve your credit score, and paying them down further to less than 50% significantly increases it the more.

If you decide to pay off your debts, work with a personal budget that factors in your income expenses so you can live comfortably within your means while ensuring that your debts are getting paid.

Debt Repayment

Your debt repayment strategy may be different from your neighbor’s. You could defer payments or ask for forbearance or forgiveness of loans via your lender if you have student loans. These options won’t be available if you owe money on your credit cards.

The snowball and avalanche methods are the two main repayment methods, regardless of the type of debt you owe.

The Snowball Effect

The snowball involves outlining your debts based on the total amount to pay them off in order of size. The strategy is based on the psychological advantages of debt repayment. When they pay off the smaller sums first, people feel good, which helps lift the psychological weight of debt.

The Avalanche Technique

On the other hand, the avalanche technique prioritizes paying off the debts/loans with the most interest rates while making minimum payments on other loans each month. It ranks loans according to their interest rates. People with credit card debt, student loans, or some other sorts of loans can benefit from using this strategy.

A simple trick is setting aside any unexpected money (gifts, bonuses, etc.) to pay off debt. This trick works best when you spend less during grocery shopping and when you have extra money in your monthly budget.

Why You Should Save 

Create Savings For Emergencies And Get Out Of Debt

If you have a high-interest rate debt, it may make more sense to you to funnel all of your money to clear it off as soon as possible. A sudden illness may set your finances back several notches. That’s not ideal, as you may get stranded if an emergency arises. Squeeze aside money to build an emergency fund catering to unexpected expenses. Then you may rely on high-interest credit cards or personal loans to cover these emergency expenses. 

As you’re saving money towards an emergency fund, open high-interest savings account so your money as you focus on clearing your debt. As you fund your emergency savings, you must make minimum payments on your debts to prevent potential damage to your credit scores and accompanying late fees.

The Balance: Pay Debts And Set Small Savings Aside

The problem with most people is that their debts are astronomical compared to their monthly income. So, it would take years to clear the balance to zero. While it may be tempting to focus on clearing all your debt as soon as possible and postpone savings to the future, that’s not ideal and realistic. 

However, you can strike a balance between paying off your debt and building a small savings reserve for emergencies. Then once you’re done with debt repayment, you can save more aggressively by contributing the full amount you were paying each moment towards debt.

Here’s how finding a balance works. First, create a financial budget with the most significant expenses. Determine if you have enough savings to get through a financial emergency. Then track your expenses for a month, so you know what you spend. After saving up to cover three months’ expenses, you can now focus on paying off debt. 

From accounting for your daily and monthly fixed expenses, you can divide your income between saving and paying down your debt. This way, you have a systemic way of repaying what you owe while building small savings. Once you increase your earnings or income, you can always increase your monthly debt repayments.

 

Disclaimer

Information provided on InflationCents.com is for informational/entertainment purposes only. This information should not be considered as professional advice. Please seek a certified professional financial advisor if you need assistance. Rates and offers provided by advertisers can change frequently and without notice. We attempt to provide up to date information, but it could differ from actual numbers. Inflationcents.com may be compensated by 3rd party companies that are mentioned either through advertising, reviews, affiliate programs, or otherwise. All reviews and articles are based on objective analysis and no compensation will tilt our opinion.

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