Living from salary to salary greatly impacts your financial choices. You may face expensive credit card balances but can not afford to pay off debt, or you may want to save for college or retirement but can hardly meet your monthly bills. However, if you get a new job that pays well or get an additional source of income, the extra money could provide enough disposable income to pay off your debt or start saving. But what do you do first?
Opinions among financial experts vary, and there are benefits to both approaches. Consider the various reasons for both methods and find out if it is better for you to pay off the debt or save the money.
Saving money or paying bills: why pay off debts first?
No one likes debts, and without the right level of income, high debts can follow you for years. But if you have money, here are three great reasons to pay off debts before you save your money.
Eliminate Interest Payment
Most indebtedness pays interest monthly. For example, credit card interest and overdraft are the highest interest you can afford and very common nowadays. The high rates make it difficult to pay off debts, especially if you fall into a routine of just paying your monthly minimum for every debt you have. This is because a large portion of your minimum payments are applied to interest charges and not to principal. The idea is to pay off your debt as soon as possible, otherwise you will be paying only the minimum every month and seeing your card debt increase because you are not paying the principal amount that was borrowed.
Improve your credit situation
If you are trying to improve your credit situation to qualify for a mortgage, loan, or financing, paying off your debt first can kick start your plans. Your savings history with your bank does not necessarily contribute to your credit, but if you want to prove your credibility, paying your debts will add good credit points to get more financing and loans with ease.
Deciding between saving and paying off your debt does not have to be a difficult task. Just think a little and make a good budget. (Photo: Kiplinger)
Get peace of mind
If you owe hundreds or thousands of dollars in debt, you are likely to know the anxiety that this can bring. The thought of paying thousands of dollars in interest in addition to your debts can make your stomach flip. If you seek relief from this stress, paying your debts as quickly as possible is the best course of action. Also, as long as you want to save money, you can end up with a deeper debt if your interest rates are high.
Paying debts or saving money: why save money first?
Would not it be nice to watch your investment accounts grow month after month? If you focus on saving money before paying off debts, you can achieve your dreams sooner.
You have a low interest rate on your debts
If the rate of return of your investments is more than what you are paying in interest on your debts each month, saving before you eliminate debt has good results. Let’s say you have a small debt on a personal loan and a low interest rate. You can pay off your debt over time and put your extra money into savings. However, this approach does not benefit everyone. It is important to carefully understand the interest rates and see if they will not increase over time. This ensures that debt is controllable longer.
Create an emergency fund
While debt repayment first helps to provide more credit and offers peace of mind, it does not help during a financial crisis. If you put all your money in relation to debt repayment, you will have nothing save for difficult times. Create an emergency fund with the equivalent salary of six to eight months can help you in case of job loss, divorce or illness. It also prevents you from taking on deeper debt in dealing with an emergency.
What should I do?
Deciding to pay off debts or create a savings first depends entirely on you. Evaluate your personal financial goals and decide which is most important.
If you can not make a decision, why not enjoy the best of both worlds? Take your available monthly income and divide the money evenly between your debt and your savings. It will take longer to pay off the debt balances and your savings will grow at a slower rate. However, in the end, you reach your two financial goals and once your debt is gone, all of your extra income can go towards saving.