Awa Sow
Saving and paying off debt are both very important goals when it comes to personal finance. But when you are tight in your budget, you might not have enough to spare for debt payment and for Savings. So, which one should you prioritize? This will depend on your situation and on a few other factors.
What type of debt do you have?
If you mainly have credit card debts at high interest rates, it might be a good idea to pay off that debt first before thinking about saving. High interest credit card debt can really slow you down in your Financial Journey. Most credit cards are offered at about 20% interest rate and depending on how much money you owe, the interest payment can really add up.
Just to give you an idea if you owed $5,000 in credit card debt at a rate of 20%, you would be paying $83.33 just in interest every month. You might be thinking that this is not much. But this money adds up really quickly. Imagine if you had decided to put this $83.33 in your savings account for a year, you would have accumulated $1,000. And this is not even including the interest that you would be earning in your savings account.
So as you can see, depending on the interest rate of your current debt you might be better off paying off debt as quickly as possible and then focus on your savings. There are a lot of different options you can use to pay off debt which we will talk about in a different post.
Paying off debt and not saving
If you decide to only focus on paying off debt and delay saving, you will sort of create another problem, which is that you won’t have any savings in case of an emergency. Remember that in my other videos I talked about having an emergency fund and the importance of it. If you don’t have any savings and your car breaks down, for example or you have a plumbing situation or even lose your job, you won’t have any other option than to fall back on credit to resolve this issue. A lot of people keep doing this and this is why they have a hard time getting out of debt.
It’s as if you take one step forward and two steps back. And let’s face it, emergencies just fall on your lap and they happen without even a warning. Which is why they’re called emergencies in the first place. So, you need to be prepared in case of such a situation.
Saving and only making minimum payments towards your debts
If you were to decide to focus on saving money and only making minimum payments on your debt, or not pay your debt at all, you will lose more money over time in interest payment. Although in this option you would have some money saved up, it would however be as if all of this money is not for you because you owe some lenders. Since no savings account can give you a better interest rate than the rates you are paying on your debt, you are better off paying your debt which will help you save a lot of money in the long run.
On top of that, if you only focus on saving while having a significant amount of debt, you risk retiring and still have debt to pay off. Which might not be a good idea since your earning potential will most likely decrease when you retire. Therefore, you will have less money to budget and will have an even harder time making your payments.
Should you save or pay off debt?
I say do both. You can find a way to balance both of these goals at the same time. Ignoring one of these can have a negative impact on your financial Journey. Only focussing on debt payment and ignoring your savings will prevent you from taking advantage of the compounding effect of saving. Essentially the compounding effect of saving is the fact that the longer you save the more your money has time to grow.
Keep in mind that tphe longer you wait to save, the more money you will have to put away when you start saving in order to reach your retirement goal.
On the other hand, only focussing on saving makes it so that you’re losing more and more money in interest payments the longer you wait to pay off your debt.
You might want to adopt some sort of a blended approach and save money while you pay down your debt. saving while you have debt is good because it puts you in the habit of saving. Once you notice the power of saving and see how much your savings account is growing, you won’t want to stop.
So, here is my Approach: I propose building up an emergency fund first and then focussing on paying off debt to prevent you from borrowing back from your credit cards and therefore alienate all of the hard work you’ve done. Ideally, you should have 3 to 6 months of living expenses as an emergency fund in case you lose your job, for example.
However if this seems difficult at first, I suggest putting away about $1,000 to $1,500 to cover certain unexpected expenses. Once you have accumulated this amount, aim to put a small percentage of your salary in your emergency fund account while paying off debt so you can start to slowly build a solid emergency fund. Every penny counts. Even if you only have $20 to put in a savings account per month, it will add up over time
Don’t forget to also save for retirement while you are paying down debt as this will put you in a savings spirit and you will start to slowly build up your retirement savings.
Bottom line
Saving and paying off debt are both very important goals in your financial journey. You should not prioritize one at the expense of the other. You should rather find a way the practice a healthy balance between the two. Keep in mind that no amount is too small for saving or paying off debt because every little bit put you closer to achieving your goals.
