Should you pay off debt or save for the future?

Everyone knows that it’s important to save for the future, but if you’re in debt, it can feel difficult or foolish to save when you could be paying off your debt instead. Deciding which to prioritize can be a complicated financial decision, so it’s normal to feel stressed or confused about it.

We’ll break down what you need to know about when you should pay off debt or save money and what steps to take when you’ve made the decision.

When you should pay off debt

When you owe money to a lender, it’s normal to feel like you should pay it off right away. However, some types of debt aren’t necessarily a bad thing, so it’s important to think carefully about whether it’s important to focus on paying it off.

These are some factors that contribute to whether debt repayment should be your priority.

• Interest rates. The higher the interest rate of a loan, the faster interest accrues and the more you have to pay to clear your debt. Focusing on paying down high-interest debt can save you money and give you room in your monthly budget. If you are thinking about taking out a personal loan, for example, you may want to look at average personal loan interest rates to determine how much you’ll have to pay for taking out the loan. If you’re able to get a low interest rate, it might make sense to take the loan or take longer to pay it off.
• Credit score. If your high level of debt is dragging down your credit score, you may want to prioritize paying it off. A common rule of thumb is to keep your credit utilization below 30% to keep your credit score high.
• Debt-to-income ratio. The more of your monthly income that goes toward your debt, the harder it is to make ends meet and the harder it is to get new loans. If your DTI ratio is high, consider paying off some loans to lower it.

Ultimately, having too much debt can make it hard to do things like buy a home or car and can mean spending money on interest to the detriment of savings goals. Try to avoid high-interest debts, like credit card debt, and if you do have high-cost debt, try to make more than the minimum monthly payment to pay it down quickly.

If you think that paying off debt is the right priority for you, consider these steps.

Choose a debt repayment plan

The first step on your debt repayment journey is to figure out which payment method you’ll use. There are two main strategies:

• Debt snowball. The snowball method focuses on paying off the smallest balance debts first. Then, put whatever money was going toward payments on that debt toward the next one. You get quick wins by paying off small debts and can snowball the payments toward larger debts. The downside of this strategy is that you may pay more interest overall.
• Debt avalanche. The avalanche method focuses on paying off the highest interest debt first. This saves you the most money in the long run, but it may not result in you paying off any loans quickly. If you’re struggling to pay all the bills, you may prefer the snowball method to give you more flexibility in your budget.

Both methods of paying off your debt are effective. Which you choose will depend on your financial goals and your sense of what will motivate you. For some people, the quick successes offered by the snowball method can be motivating, while for others, the greater savings of the avalanche method will best help them reach their goal.

Consolidate your debt

Debt consolidation is another way to pay off what you owe faster. Debt consolidation involves taking out a new loan and using it to pay off multiple other loans. It leaves you with one, hopefully lower interest, loan and monthly payment to deal with rather than multiple loans.

Consolidation usually requires a solid credit score, so it may not be an option for everyone.

Two popular ways to consolidate debt are personal loans and 0% APR credit cards. Typically, personal loans offer higher loan limits and longer terms, so they’re better for consolidating larger amounts. You can prequalify for a personal loan to see the terms offered to you and make a choice that’s right for your personal situation.

0% APR credit cards charge no interest for a period usually ranging from 12 to 18 months. You would apply for a balance transfer credit card and then transfer your high-interest debt to this account. However, you may have to pay a balance transfer fee.

After that period, the interest rate returns to the a higher annual percentage rate (APR), so these are best for smaller debts you can pay back quickly.

When you should save money

Depending on the size and type of debt, it may take you a long time to pay off all of your loans. Mortgages last 30 years, and auto loans can easily last five years or more, and that’s a long time to put off saving for the future.

Coming up with a savings plan sooner rather than later can put you in a better place to achieve goals like retiring.

These circumstances favor starting a savings plan

There are a number of scenarios where saving can be a better plan than paying down your debt.

• Your debt has a low interest rate. If most of your debt has a low interest rate, it can often be okay to keep it around and focus on saving and investing.
• You have no emergency fund. Without any emergency savings, an unexpected bill will just make you borrow more money, so building an emergency fund should be a priority.

While it can be hard to figure out if you have good debt that you can keep for a while, if you’ve decided to save, use these tips.

Build an emergency fund

One of the most important financial steps for anyone to take is to build an emergency fund. Just like its name implies, an emergency fund is designed to be a source of funds when you get hit with an unexpected financial emergency, like a car repair or a medical bill.

If you’re not sure how much your emergency fund should be, you can start with a goal of $1,000, which would be enough to cover an unexpected small car repair or medical bill. This will help you avoid going into high-cost debt to deal with an unexpected expense.

Set up a retirement fund

Retirement can seem like it’s a long way off, but saving smaller amounts over the long run can often be more effective than trying to save a lot just before you retire.

For example, if you save $3,600 a year over a 40-year career and earn an average return of 6% per year, you’d retire with more than $550,000. Saving four times as much for the last 10 years of your career would leave you with just under $190,000 even though you’d put the same amount of money into your retirement fund.

Many experts recommend putting around 15% of your monthly income toward retirement. If you can, try saving through an IRA or 401(k) to get tax benefits for saving for retirement.

Take advantage of employer matching contributions

Many employers offer a 401(k) retirement account that you can use to save for the future. One benefit of a 401(k) is that you won’t pay income tax on any money you save, so each dollar you save effectively costs less than $1 out of your paycheck.

Your company may also offer to match some of your contributions. Imagine you make $50,000 per year. Your company may match your contribution by 50% on up to the first 6% of your salary you contribute.

What that means is that if you put $3,000 into your 401(k), your employer will add $1,500. This is like getting free money for retirement, so try to max out your employer match if possible.

How to save while paying off debt

Nothing in life is black and white, and the same is true when it comes to deciding whether to save or pay off debt. For many people, the proper thing to do is both. You don’t have to choose just one or the other.

Start by building a budget that accounts for all of your spending, including payments toward credit card debt. Then, see if any of your debts are costing you a lot each month. If they are, consider paying them off first. Then, once you have some breathing room in your budget, think about how you can save each month while also paying down debt.

You could also consider consolidating your debt using a lower-cost loan, which can make it easier to manage and give you the chance to start saving while paying down your debts.

The bottom line: Choosing to pay down debt or save depends on financial circumstances

Deciding whether to save or pay down debt can be tricky. In general, the best path to take is to build a small emergency fund, then pay off high-interest debt, and finally strike a balance between paying off your remaining loans while saving for the future.

If you’re ready to start paying off debt and think that debt consolidation is the right path for you, consider applying for a personal loan with Rocket Loans.