Here’s an important, potentially tricky, question. Do you pay off your debts or save up? Do you try to do both at the same time? What’s the right move, in this situation?
The simple math tells you that debt should be your first target. However, this isn’t always the case. Working on losing your debts first isn’t always the right call. First, let’s look at when debt should be the priority before savings or retirement.
When your debt has high interest, cutting it down first will solve ongoing financial problems. Consider cutting the interest payments a “return on investment.” This helps give you a little more room to move around, and it’s arguably more than you’d earn in a savings account.
To do this, you need to focus on the debt. Make that the biggest part of the budget equation. Find every way you can to save on the debt, including consolidating all of it onto a low-rate card if possible.
Remember that in most instances, paying down a traditional loan – as opposed to credit card debt – only cuts the principal and related interest. Extra payments can save you money in the long-term, but not so much in the short-term.
If you have tax-deductible debt, you’re better off saving overpaying. Yes, you lose the tax deduction, but it’s not a big amount. The deductible is of less value than the annual interest on the loan, so you’re in a losing proposition by not getting rid of it sooner.
Now, let’s look at the other end of things. What are the times when you want to save, despite the debt?
The best reason for saving now and paying later is emergencies. If you want to have a reliable fund that you can tap for emergencies, it’s better to save now and pay off debts later.
Another instance when savings should be put ahead is in low-interest rate environments. Focusing solely on your debt can cripple you financially in the event of the unexpected. If your interest rates are low enough, you can afford to have savings or investments without risking default.
If you have retirement savings plans or benefits through your job, it’s important to save before you pay your debts. Match the employer’s contribution if possible. This takes advantage of the ability to build for the future early on, which is important for anyone that plans to retire comfortably.
When should you attempt to do both? The best financial advice on that is when you can afford to do so. This means having a small, manageable debt and sufficient income that you can pay it off and have some extra left at the same time.
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