Paying Down Debt or Saving for the Future: Which comes first?

When money is tight, it must be used especially wisely. Maybe you are struggling each month to make ends meet and want to use that small amount of money left over in the best way possible. On the other hand, maybe you have access to a bit more money than usual and are looking for the ideal way to use it. Whatever the case, many individuals have to decide which of two very important routes to take with limited amounts of money: to pay down debts -- or to save or invest?

As (unfortunately) is the case with most financial matters, there is no “right” answer when it comes to deciding whether to pay off debts or to save one’s money. In large part, it depends on the make-up of one’s debts, but it also depends upon personal preference. Read on for suggestions of the situations in which you might want to pay down debts first, and of those in which keeping that money for yourself might be a better idea.

Paying Down Debts First

In general, debts that you will want to consider paying off before you use “disposable” money to save or to invest are “bad debts”. These debts are those that do not represent an investment in your future and for which you end up paying long after the usefulness of the product or service has run out. Credit card debt is a very common example.

Bad debts usually have very high interest rates attached, so objectively it would not be “worth it” to invest money instead of using it to pay off a debt unless the interest rate on your investment is significantly higher. So, if your credit card has 18% interest, then you probably should not be saving money unless your account or investment has an attached interest rate of 20% or higher!

Some experts feel so strongly that you should pay down high-interest debts before saving, that they actually suggest taking a bit of money out of investments in order to pay them off. If your debt situation is truly desperate, then you might want to liquidate some of your financial investments and use part of your savings to pay down debt. In the most serious of situations, some professionals even give the “ok” to taking small amounts of money out of IRAs or 401(k)s.

Most people, even if they are responsible for large amounts of high-interest debts, still feel like they should be saving something. And saving money – or paying oneself first – is very important. Read on for scenarios in which saving or investing money might be better than paying down debts.


Saving or Investing First

If experts recommend paying down bad debts before saving, then it should come as no surprise that many also suggest not paying down good debts before setting money aside for oneself. Large expenses that are investments in one’s future, or that are particularly long-lasting and important, are considered good debts.

One type of good debt with which many people must deal is student debt. Incurring large amounts of educational debt is unavoidable for most people seeking higher education, so what to do with the money one starts making from his or her degree is a common concern.

The interest rates attached to most student loans, especially federal student loans, are comparatively low, and under new legislation interest payments now can be written off of tax returns indefinitely. While you want to make your monthly payments, there is little reason to use large amounts of your income to pay down this debt quickly.

A mortgage is another example of a “good debt” that you should not be too concerned with paying off quickly. If you have large amounts of extra cash sitting around then that’s one thing, but otherwise there is nothing wrong whatsoever with slowly but surely paying off good debts, while investing and saving money elsewhere.

So, what is the best way to go about saving and investing? As far as saving goes, we are going to drill in your brain just one more time the importance of having an emergency fund. It might seem counterintuitive to set money aside for some rainy day when you owe money now, but “paying yourself first” really is crucial.

Having an emergency fund definitely will not seem like a waste if you suddenly need to use it. If you fail to have a savings, however, and then have an unexpected expense arise, you probably will find that your already stressed financial situation becomes dire. It is very important to get into the habit of saving each month, no matter how little money you are able to save.

Investing includes accounts such as 401(k)s and IRAs that must be built up for your future. Taking longer to pay off your good debts while investing money for such crucial purposes almost certainly is “worth it”.

It is important to note that, even if you choose to invest and save instead of paying debts off quickly, you still need to have some sort of plan in place for paying them off. It is important to save after paying off bad debts, but you also should come up with a strategy for paying off good debts by some specified date.

Conclusion

To determine your best strategy for paying off debts and investing/saving for the future, start by assessing your individual debts, interest rates, priorities and financial goals, and consider how these fit in with professional opinion. For more tips on paying down your debt, visit the DebtHelp.com Knowledge Center.