Carrying a debt load can be costly, so consumers are often anxious to pay off outstanding debt balances. Then again, putting money into a savings account is important too. There is a constant dilemma between spending every spare dollar to pay down debt or stashing it away for a rainy day. The answer as to which one is the best option for you depends on your financial situation and goals.
Argument for Paying Off Debt
Here are a few reasons why you should consider paying off debt first.
It's no secret that interest rates on credit cards and loans are sometimes through the roof. Because of this, you can end up spending much more on a purchase than you think. For example, if you make a $650 purchase on a credit card that carries a 16.99 percent interest rate, only making the minimum payment of $20 per month will stretch the repayment period out to 4 years. To make matters worse, you will end up spending $227 in interest.
The quicker you pay off your credit cards, the faster you can start putting the extra funds away. And while some may argue that the available balance on the credit accounts can serve as a cushion, just keep the interest rate in mind.
Completely neglecting to allocate extra funds to credit card payments will likely cause the interest to spiral out of control month after month. The debt multiplying exponentially at a rapid rate will make the payments a lot more uncomfortable when you do finally decide to attack them aggressively. Also, keep in mind that interest never sleeps, so the longer the debt remains, the worse off you will be.
"From a purely financial standpoint, the more you're paying in interest charges on your debt, the more you gain by paying it off," notes Daily Finance.
Improve Credit Score
Since a large portion of your credit score is determined by the amount of outstanding debt you have on hand, quickly reducing these balances is beneficial to your profile. You will likely save money in the future if you apply for financing, as those with the highest scores are usually offered the lowest interest rates.
Argument for Saving
Here are a few reasons why you should consider allocating funds to your saving account.
If your cards are practically maxed out, an emergency fund is mandatory as you will need the extra funds if an unexpected financial emergency arises.
According to Nerd Wallet, going into debt when unexpected emergencies happen can make it much harder to eventually get all the debt paid off. "You will almost assuredly deal with some type of emergency between now and whenever your debt is paid off. Be prepared."
In addition, you cannot count on qualifying for additional credit elsewhere in the event of an emergency as they may deny your application because of the other account balances that already exist. Think about instances where you may need car repairs, incur medical expenses or become unemployed. And even if you can get a cash advance from a credit card, the transaction is often accompanied by a hefty fee and higher APR.
Does the thought of using all your spare funds to pay down debt scare you? Maybe you fear not having an adequate amount of funds on hand to cover financial emergencies. Whatever the case may be, it is best to save first if doing otherwise will cause more stress. Plus, you may have no desire to live from paycheck to paycheck.
Low Interest Rates
Assuming you have installment debt, such as a mortgage or auto loan, it is not a bad idea to continue saving as the interest is already factored in and is not revolving. Also, aggressively tackling these debts may wipe out any disposable income and take an extended amount of time to pay off.
If your employer offers matching contributions to your retirement fund, you may want to consider contributing to the maximum amount in order to take advantage of the free money used to build your nest egg. It is not wise to focus so much on your debt until you have no means to sustain yourself after retirement.
"On the savings side, if you have access to an employer-sponsored retirement plan, you'll want to contribute enough to at least get the employer match, assuming there is one," states Forbes.
The Choice Is Yours
Depending on your current financial situation, it may be feasible and wise to do both to feel a sense of balance. In addition, you can kill two birds with one stone. Consider building up a small emergency fund, and then when that is in place, aggressively attack your debts. You can then return to adding to your savings after your revolving debt has been paid off.