Eliminating debt is just as important building up savings.
In a perfect world, we would all live debt-free lives with full savings accounts—but it’s not a perfect world and chances are that you will accumulate some debt at some point in your life, if you haven’t already. But here’s the question—does having debt automatically preclude you from having savings? In other words, is it more important to direct any extra money toward paying off debt or toward beefing up your savings account? Let’s explore.
The Problem with Debt
Whether debt is considered “good debt” or “bad debt”, all debt shares one characteristic—it’s stressful. Some debt carries high interest rates. All debt hangs over your head. Debt is a way of borrowing from tomorrow to pay for yesterday. It’s no fun to feel like all of your money is directed to a past expenditure when you’re trying to move forward and enjoy today and tomorrow.
The Importance of Saving
The importance of saving money is no mystery. A healthy savings account provides a cushion of safety for any number of curve balls that life can throw your way—such as illness, job loss, or disaster. In fact, having a savings account can prevent you from accumulating debt in the future because you’ll have an emergency stash of cash to draw from.
Which Comes First?
So what should you do first—pay off debt or accumulate savings? Financial experts disagree on which is more important, probably because they are both so vitally important that it’s difficult to choose.
There are some legitimate reasons to pay off debt first:
- Reduce interest: Most debt comes with interest. The sooner you pay it off, the less you’ll pay in interest over time.
- Improve credit score: Your debt-to-income ratio is used to determine your credit score. In fact, the amount you owe accounts for 30% of the score. The less debt you have, the higher your score will be.
- Eliminate stress: Debt often comes with a high level of chronic stress and anxiety. Even if you’re not consciously thinking about it, it is always in the back of your mind. Paying off your debt will bring you peace of mind and relieve you from the stress of the debt cycle.
There are also some good reasons to focus on savings first:
- Earn interest: The sooner you start saving, the sooner you can take advantage of earning interest on that money and letting your money grow and accumulate. Savings happens over time. The best time to start saving—yesterday, last week, last month, last year. Just start.
- You have low-interest debt: If you have a low interest rate on the money you owe and a higher interest rate on the money you’re saving, then it makes good financial sense to go ahead and start saving. Just be careful to watch for scheduled increases in your credit rate. For example, this approach makes perfect sense if you have a 0% credit card, but when that rate makes a jump it will be important to adjust accordingly.
- Build a cushion: If you direct all of your money toward paying off debt, you’ll have no cushion for the next emergency or expense that comes along. Creating an emergency fund will provide a cushion and prevent you from going deeper into debt.
Either, Or, Both
Choosing whether to eliminate debt or create savings is a personal decision and depends on your own financial situation and goals. There are pros and cons to each approach—and the bottom line is that it might not be an either-or decision. Some people find that it makes sense to split payments evenly between debt and savings. This will mean that it will take longer to eliminate debt and accumulate significant savings; however, you’ll be working toward both goals at the same time. Once the debt is gone, all of that money can go toward savings. In the meantime, you’ll have a small cushion in case you need it. Whatever you decide, best of luck in creating a healthy financial future!