It can be difficult to decide if you should focus on reducing debts or saving for the future—and the answer is different for everyone. Knowing the types of debt you carry can help identify where you can make the most impact with your money. That’s why we broke down the battle between building savings and paying off debt:
- Round 1: Emergencies. While paying off debt is important, it's also crucial to have an emergency fund should the unexpected occur. Not having cash reserves during these periods in life can actually be counterproductive financially because you may need to incur even more debt to cover unexpected expenses. Round 1 goes to building savings.
- Round 2: Interest Rates. Interest should play a big part in deciding whether savings or debt payoff should win the day. That’s because some debt comes with hefty interest rates, and savings accounts tend to grow money at a much lower rate. As a result, putting money into savings instead of paying off the debt can be like taking one step forward and two steps back. Instead, consider focusing your money on paying off your debt with the highest interest rate first. Round 2 goes to paying off debt.
- Round 3: Head to Head. Finding the right financial balance depends on your current savings, accumulated debt and future goals. Examine the types of debt you carry and the options you have for saving money.
- Types of Debt. Not all debt is bad. For example, home mortgages and student loans are often considered good debt because interest rates are often low and the interest paid may be tax-deductible. Bad debt often carries a high interest rate and doesn’t generate income. Evaluate what kind of debt you’re carrying to figure out if you should focus on paying it off right away.
- Savings Options. The type of account you choose for savings also makes a difference. For short-term goals, you may want the convenience and easy access of a savings account or certificate. For long-term goals, such as saving for college or retirement, you may decide to open an Education Savings Account or Individual Retirement Account (IRA) to enjoy their tax benefits. Additionally, if your employer offers a retirement plan with matching contributions, you may choose that route—otherwise, you’re missing out on free money from your employer. Instead of an all-in approach, it’s wise to strike a balance between debt and savings, and continue making regular payments on your debt and saving money every month—even if it’s a small amount. Therefore, Round 3 is a tie.
- Final Stats. Wherever you are with paying off your debt and building your current savings, it’s important to keep both moving forward.