Does it make sense to try and save while paying down debt? Most of us understand the importance of saving. However, we also know the negative results of carrying too much debt. What should you do with extra income, pay down debt or save more money? Unfortunately, there is not a simple answer. The best solution is to create a financial strategy that balances both priorities. Consider the reasons behind both scenarios, placing debt elimination as the highest priority or banking as much cash as possible.
Give Debt Reduction the Priority
- Pay less interest. The quicker you can pay off credit card debt, the less interest you’ll pay over time. For example, if your credit card has a 22 percent interest rate on a balance of $5,000, you’ll end up paying over $8,000 in interest if you only make the minimum payment of $141. However, if you can pay an extra $500 per month, you can pay the debt in almost one year and pay only $541 in interest.
- Improve your credit score. If you are trying to apply for a mortgage or auto loan, paying off debt quicker can improve your overall credit score, allowing you to qualify for lower interest rates.
Give Saving Money the Priority
- Create a cushion. Most experts recommend having a six to eight month emergency fund. If you send all your money to your credit card company, you’ll have nothing left in case of an emergency. The result will be continuing the debt cycle since you’ll have to charge necessary expenses. Put something away for a rainy day so you don’t continue to add to your debt.
- Take advantage of a low interest credit card. If your interest rate is low or even zero percent for a specific time period, take advantage of that time to save some cash. However, read your credit card agreement carefully. Many interest rates jump to over 20 percent at the end of the introductory period.
At the end of the day, it makes good financial sense to pay off debt and save money. Depending on the amount of debt you have, your interest rates, your savings account rates and your financial goals, each family should come up with a strategy that works for them.