In 2019, about 69% of college graduates took out student loans to afford their tuition. That means that the vast majority of graduates are carrying student debt. And students aren’t the only ones dragging debt around. Between student loans, home loans, auto loans, and more, 80.9% of baby boomers and 81.5% of millennials are in debt. If you’re carrying debt, it may be tempting to prioritize paying it off above all else. But it’s also imperative to start saving for your future early in life. So how do you know where to start? What should you do first: pay off debt, or save for your future?
Why you should prioritize your debts
Improve your credit
Your credit utilization ratio — the percentage of your total credit line that you’re using at a given time — has a large impact on your credit score. That means that if you’re deeply in credit card debt, it’s seriously hurting your credit score.
A low credit score makes your life difficult in a number of ways. It makes it harder to get a loan, get an apartment, and even get a job. If you’re struggling with a low credit score, paying off your debts sooner might make your life much easier.
Avoid accumulating further interest
The longer you carry your debt, the more interest you’ll accumulate. And if you’re carrying high-interest consumer debt, that interest can add up fast. If you let it go for long enough, you could end up doubling your debt.
Has your debt snowballed out of control? The right debt settlement firm can help.
Why you should save first
Emergencies are expensive
Using all of your disposable income to get out of debt is a noble endeavor, but what happens when disaster strikes? If you have to pay off an emergency medical expense and don’t have any savings, you might have to finance the procedure with a personal loan. And that brings you right back to where you began.
And saving isn’t just about the present day. It’s crucial to start saving for your retirement as early as is humanly possible. That’s because saving money in a tax-deferred or tax-free retirement account lets you accrue a ton of interest over a period of 50+ years. In other words, the sooner you can get some cash into a retirement account, the better.
Avoid prepayment penalties
Many loans charge prepayment fees — penalties for paying off your loan early. Why? Because when you pay off your loan early, lenders lose profit that they would have made in interest. If a lender charges prohibitively expensive prepayment fees, it might be better for you to keep making your required monthly payments rather than overpaying early and often.
Plus, if you play your cards right, high-yield investment opportunities can net you more profit than you’d save in interest by paying off your debts early. Browse top brokerages to find out what kind of returns you can expect.
So what should you do first? Pay off debt, or save?
Build an emergency fund first
In order to prepare for the worst (and prevent further debt), building an emergency fund should be a top priority. Your emergency fund should include enough money to cover your rent and expenses for six months. But don’t let saving for an emergency fund make you late on any of your loan payments. If you need help figuring out how much to put away each month, check out these helpful money management tools.
Follow the 7% rule
If you need to decide whether some extra cash is better spent on investments or on early loan payments, just follow the 7% rule.
The average return on the S&P 500 is 7%. That means that if your interest rate on your loan is lower than 7%, you could make more money on the stock market than you would save by paying off the loan early. Accordingly, if you’re paying more than 7% interest, you’d save more money by paying off that loan as soon as possible.
Take advantage of 401(k) matching
If your company offers 401(k) contribution matching, you should take full advantage. That’s because 401(k) contribution matching is a great way to maximize your retirement fund at little cost to yourself. You should try to contribute as much as your employer will match — typically 3%.
All things in moderation
In general, it will benefit you to save and make early loan payments in moderation. If you have any high-interest consumer debt, you should pay this off as early as you can. But you should also allocate some of your savings to kickstart your retirement fund. And it’s wise to invest early and often in low-risk, long-term investment funds.
Not sure where to start? These money management tools can help you set a budget and build an emergency fund. And these top brokerages can give you a leg up on the investment world. If you want a more personalized touch, consider finding an experienced investment advisor. And if your debt has snowballed beyond your ability to reckon with, the right debt settlement firm can help.