The debate between paying debt first and saving more money first continues to rage. Conventional finance wisdom tells us that getting rid of debt; especially the high interest ones is a sound financial move. It makes perfect sense considering that saving accounts often offer paltry interest rates. Rather than put your money where it’s barely earning, you’d better pay off debt that suck you out in steep interest. It’s common sense at the end of the day.
But important decisions like personal finance, however, are rarely straightforward. There are no absolutes that apply to everyone. Paying debt first may work for some but not necessarily to all. When considering two vital options such as getting rid of debt and saving, balance is the key.
In order to find the right balance between saving and paying debt, understanding your financial situation is imperative. You need to take a full look at the entire picture. How much debt do you owe? Make a list of all your debts ranking them according to interest rates. Take note of debts with the highest interest rates. Now take a look at your income. How much money is coming in each month and how much are you currently setting aside for savings? Do you have extra money you can use to expedite paying off your debt?
After looking at your situation, the next step is to set your priorities. At this point, you’ll have to choose whether paying debt before saving or saving before paying debt is better for your situation.
Paying debt before saving is often recommended when you have credit card debts with steep interest rate. If the interest of such debts is higher or double of that of your savings then simple mathematics tell you to get rid of them first. In fact, the best approach with high interest debts is to pay them off as quickly as possible.
If you have extra income you can allot for paying off debt then you should go ahead and do that. If you have savings you can use to pay off debt quickly then it’s also worth considering doing just that. The key is to get rid of the interest so you can start saving and have it earned a considerable income at the end of the day.
Those who advocate saving before paying off debt, however, may disagree and they have good points too. After all, having a substantial emergency fund to cover for unexpected expenses is also very important. Without an emergency fund, you may end up in debt anyway. So instead of using up all your savings to pay off high interest debt, the much better approach is to make sure you have 3 months to 6 months’ worth of living expenses for emergency fund before you go ahead and get rid of you debt.