If you are fighting to pay off debt, the idea of recommending saving at the same time must sound absurd. After all, it seems reasonable that you want to pay off the debt as quickly as possible! But is it always the wisest choice to do so? You might be surprised to learn that there are some situations where saving money is preferable over paying off debt. Let’s examine how to assess your own situation to decide when deciding on the issue of prioritising debt v saving.
Interest Rates
The main deciding element in deciding whether to save money or pay off debt is that not all debt is created equal. Debt comes in two basic varieties: low-interest debt and high-interest debt.
A first factor to consider when deciding whether debts should take precedence over savings is interest rates. The usual rule is that you should pay off debts with interest rates exceeding 7% before starting to save and invest. On the other hand, if the interest rate on the debt is around 7%, you might choose to start investing and saving while you pay it off.
I’ll go into more depth about this later, but in general, you can invest the money you would use to pay off debt to make more money.
Priorities
You must first grasp what you need to survive before you can decide what to save and what to pay off. Calculate how much cash you require to pay for all of your living expenditures. You need to keep track of your spending for a month to figure this out. This will enable you to identify the areas where you may save money and where you spend the most.
The next step is to create a budget. I recommend starting my free budgeting basics course if you’re new to this and exploring all the resources on my blog that are related to budgeting. Ideally, you can utilise the surplus money to start an emergency fund once all of your living expenses have been paid for.
Emergency Funds
You want to first establish an emergency fund before starting to pay off debt. Why? Doing this will prevent you from utilising credit cards for unplanned expenses and adding to your debt load while you try to pay it off.
A reserve for emergencies should cover expenses for three to six months. It’s advisable to set this money aside in a high return savings account so you can maximise your interest earnings while still having access to it in case of emergencies.
This is not a shopping account, keep that in mind. The term “emergency” refers to anything unplanned, such as unanticipated medical costs or a job loss.
Assess Your Debts
It’s time to order your debts now. This will enable you to decide how and in what sequence to pay off your debts, as well as when to start saving.
You have a variety of options for paying off debt. Here’s a favourite of mine.
Make a list or spreadsheet with the names of all your debts, their minimum payments, and the interest rates associated with each.
To establish a baseline for each month and the expense of paying them, tally up all of their minimum payments.
Choose between the debt avalanche and snowball methods to pay off your debt.
Prioritising Debt v Saving. How Much To Save?
When determining how much to save, start with your financial objective and move backward. Decide how much you want to save and when you want to achieve your goal, whether it be for a trip, a down payment, or an emergency fund. Next, go backward! For instance, you would need to save $1,000 every month to accumulate a $6,000 emergency fund in six months.
Each person’s savings strategy will be unique based on their income and spending. The most crucial thing to keep in mind is that you are saving, whether it is £20 a month or £2000.
Prioritising Debt v Saving. Do What Works For You
It may take several years to pay off debt that is so high relative to your monthly income, particularly if the loan is mostly high interest. When that happens, you should aim to save some money each month in addition to paying off your debt so that your financial goals aren’t immediately placed on hold.
Keep to your plan after you’ve found one that works for you. You’ll become an expert at saving money once you pay off your debt. It will feel so fantastic when your savings start to increase significantly as a result of you shifting all of your prior debt payments into savings.
