This post is from our regular contributor, Erin.
Have you ever wondered which you should be focusing more on: debt repayment, or saving?
Chances are, if you’re like many millennials who graduated with student loan debt, you’ve wrestled with this thought at one point or another.
Knowing which to prioritize can be overwhelming at times. There are gurus out there who declare that debt is an emergency and should be treated as such; then you have others telling you to build up an emergency fund ASAP in case something goes wrong.
On limited funds, what are you to do!?
I’ve been there, as I graduated with student loan debt myself, and also felt the need to save as much as I could because I saw my parents fall into debt due to lack of savings.
It can be difficult to deal with pressure coming from both sides, but I hope my insight into how to balance debt repayment and saving can help.
1) What Type of Debt Do You Have?
I think everyone needs to be aware of all the little details of their debt. What type of debt you have makes a difference, as interest rates are going to vary from each (you probably don’t have a 2% interest rate on your credit cards, but you might on student loans).
My advice is to list out all of your debts so you can order them in a useful way, whether that’s from lowest to highest balance, or lowest to highest interest rate.
I know this can be painful, but you have to be aware of your totals in order to know if it makes sense to focus on saving or debt repayment.
For example, if your interest rates are pretty low (2-3%), then it might make more sense to focus on saving right now. Those that do are confident their money will earn them a better return in the markets.
That might be the case, but remember to actually save your money and invest it so it’s working for you!
2) What Does Your Current Financial Situation Look Like?
After you have your debt information listed out, you need to factor in your monthly expenses to figure out how much you can realistically afford to put toward debt and savings every month.
Hopefully you’ve been tracking your expenses or have a spending plan set up, as this will make balancing debt repayment and saving easier. You’ll already know where your money is going, and you should have a good idea of what you can cut out if need be.
Tally up all your expenses (minimum payments on debt included), and subtract that from your total income each month. If you have anything leftover, you need to decide where it’s going to go: to debt, or savings.
3) Figuring Out Savings in Case of an Emergency
You already know how much you need to put toward your debt, at a minimum, every month. What should you put toward savings? Assuming you need an emergency fund, here are a few things to consider:
- How many things do you own that you’d be responsible for paying to repair/take care of? (Car, house, rental properties, pets, etc.)
- If you were to lose your job, how long do you think you’d be out of work for? Is your network strong? Is your industry doing well?
- What could you do to reduce your living expenses if worse comes to worse? Create a “backup budget” to reflect this.
Again, there are a lot of different recommendations out there on how much you need saved up. 3-6 months of living expenses is recommended, but if you’re a young adult who rents and doesn’t have much liability, then you might be okay with less.
Personally, I’m all for having some sort of savings, even if it’s $500-$1,000 – whatever you can muster. Especially if you’re at risk of falling back into a vicious cycle with consumer debt.
You can always start with saving first, and switch your focus to debt repayment once your savings fund is good to go.
4) How Long Will It Take to Pay Off Your Debt?
Now that you’ve taken stock of your financial situation, you should estimate when your debt payoff date will be based on your current income.
Of course, we can always hope things will improve, but it’s good to do a conservative estimate for the time being.
I really like unbury.me‘s debt repayment calculator as it allows you to focus on either the snowball or avalanche method of paying off debt. Enter what you can currently afford to pay toward your debt, and see how long it will take to pay back.
Is the number of years too difficult to swallow? Or are you okay with how long your journey will take?
If you want your debt gone sooner, then feel free to take that extra money and direct it toward debt payoff.
5) How Long Will It Take You To Save?
If you’re struggling with whether or not to save outside of an emergency fund, list out your savings goals.
Do you want to save for a trip, for early retirement, a new computer, or a down payment for a home?
Are your savings goals more short term, or long term? You need to compare your debt payoff and savings timelines.
For example, say it’ll take you another 5 years to pay off your debt, but in the meantime, you want to save $700 to go on vacation next year.
If that’s the case, it makes sense to focus on debt repayment while saving a little each month to fund your vacation. Saving $700 in one year should be fairly doable. The same goes for a new computer.
If you want to save for retirement, try saving in small increments (matching contributions anyone?) until your debt is paid off.
Focus On What Feels Right
Whenever you’re dealing with finances in this capacity, it’s okay to be emotional.
Maybe you’re seriously sick of your debt and you’re ready to kick it to the curb. If that’s true, then your gut could be telling you to forget about saving and to kill your debt.
On the other hand, your heart could be telling you to stash some cash away for a rainy day. You don’t want to stress about not being able to afford an emergency should one come up.
Sometimes you just need to do what’s right for you regardless of the advice others offer. Everyone’s situation is different, and you can change your focus at any time depending on that situation!
You can also decide to save and pay off debt. My minimum student loan payment is $200, but if I have $400 leftover at the end of the month, I can put $200 toward my savings goals as well. Or, I can alternate putting that $200 toward my student loans and savings every other month. There’s no right or wrong answer.
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I’d be remiss not to mention one of the benefits of side hustling is that it can help you reach either of these goals quicker. I’ve seen many bloggers pay off their debt or fund their savings with just their side income.
Bottom line: don’t base your decision on what everyone else insists is correct. Only you know what the right decision is for you. Debt repayment and saving are both awesome financial goals, and you’ll be moving in the right direction either way.
Have you had to decide between debt and saving before? What path did you choose and why?
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I’m a proponent of paying down debt while saving towards an emergency fund. Like you said, I think that savings are usually your best protection against future debt. Comparing the interest rates of your debts is also critical–there’s a big different between 2% and 18%! For example, our low interest rate on our mortgage is why we choose not to pay that down ahead of schedule–much better to have that extra money invested.
I had a short timeline for debt repayment, so I went without an e-fund until I was done. I’m not sure I can recommend this route, but it worked ok for me because I really only had about four months to go by the time I learned what an e-fund was and why I ought to have one :-) If my debt timeline had been longer, I would have wanted to save more while I was paying down, though.
I’ve actually got a very similar post for my site on this topic coming up soon. :) I agree that you need to make it personal. I didn’t save for a good part of my debt repayment an wish that I did. I think having some sort of EF to fall back on, even if it’s only several hundred dollars can go a long way towards breaking the debt cycle – especially if it’s consumer debt you’re dealing with.
This is currently something I’m still struggling with but I decided to do both. I want my debt gone ASAP so I pay more than the minimum each month even if it’s just a little and I still put some money aside to build up my emergency fund. Life is full of unexpected expenses and they’ve happened way too much for me to put off saving. Once I get my savings to a comfortable amount I’ll probably attack my debt payments more for a few months if all goes well.
Mrs. Frugalwoods Agreed on all counts! I wish my student loans were at lower interest rates as my decision to save/invest would be slightly easier. =) Emergency funds are a must for me, though.
cthesingledollar It’s a really personal decision, and I think in the end, we all have to do what’s best for us. Having a shorter timeline does help to rush through and get your debt paid off. If I had 4 months to pay off my debt it’d be really tempting to throw whatever money I had at it.
FrugalRules Yes, definitely John! I do think those with consumer debt need an emergency fund even more. I saw my parents get knocked down too many times with major home repairs and not having anything saved. They weren’t able to progress with their debt repayment because they could only afford the minimum payments.
@Chonce Sounds like we have a similar outlook! I was more aggressive with my debt repayment when I was a regular employee, but with being self-employed, I scaled back just a little in case anything happens.
I chose to focus on saving and investing because the interest rates on my student loans are very low. I did pay off some of the higher interest loans, but I was still investing/saving then. I think it’s good to get into a habit of saving, even while trying to pay down debt. Unless the interest rate was very high…then I’d prioritize getting rid of that ASAP.
I’m trying to channel my frustration with the high-interest credit cards into making serious progress this year. We are finally on the right track and I feel like if we really focus on this one goal, we might actually be able to pay them all off this year. Next year, we will start saving/investing along with paying off our other debt.
Andrew LivingRichCheaply Well said, Andrew! I agree. It’s always good to make a habit of saving, even if it’s just a little bit every month. Once your debt is paid off, you’ll have an easier time transitioning to saving more.
Harmony@CreatingMyKaleidoscope Wow, that’s awesome you’ll be able to have them all paid off this year! Having the end in sight makes it easier to go full-force with debt repayment, I think. We have a few student loans under $2,000 that I just want to get rid of!
There was a time where I was just paying debt. When my new job started in November I was able to save a little bit and attack the debt even harder. It is going good so far.
I am a big fan of paying down debt but also building up assets. As much as debt stinks and paying interest is worse, if you don’t have a good cash cushion, you are liable to get into more debt problems. The interest you pay on the debt is your fee for flexibility down the road.
I think #4 is one of the most important factors to figure out. If you can pay off your debt in 1 year, I’d consider a complete stop on investing/savings minus my small emergency fund/401K company match. If however your debt payoff plan is 10 years I think it would be not be wise to stop saving/investing, I’d also ask you reevaluate your plan, 10 years is probably a bad plan unless your loans are ginormous.
Jason @ The Butler Journal That’s great Jason!
blonde_finance That’s a good way to put it, Shannon. I think it’s possible to do both, especially when you try earning more!
EvenStevenMoney Agreed! I like that you made the distinction of saving aside from 401k matches and emergency funds. =) Those are both important!
I always struggle with that question. Our mortgage is at a low rate, but I really want to be done with it. I also know we need to save for retirement, so we do both. I admit I do think about taking a few years and throwing it all at the mortgage, even if that’s not the best thing to do according to the numbers.
We have no debt, not even a mortgage now. My goal now is to start wealth building. It’s articles like these that inspire me. Thanks! :)
This is great advice. I think the other key bit is to monitor your situation and your comfort level. Right now, I’m pretty focused on debt repayment, but as I consider changes in my career or living situation, I also consider what that would mean for my financial priorities. I have an amount saved that I’m comfortable with now, but each month as I look at my accounts, I also spent some time thinking about what could change in the upcoming month, year, etc., and how I’d respond given what I have saved now or what I could be saving if needed.
Eyesonthedollar It’s a tough thing to balance, especially with a mortgage. I’ve read stories of people paying their homes off and feeling like they have more freedom, so it can definitely come down to emotions.
kay ~ lifestylevoices.com That’s awesome – wealth building is where it’s at! I hope to get there soon.
Becca from beccasloans Yes, great point, Becca! I do the same. I really wanted to focus on paying off student loans this year, but that might change depending on things that happen with our career or living situation. It stinks to change direction when you don’t want to, but that’s life.