Paying Off Debt vs. Saving: How to Prioritize
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Few things are more important than your financial situation, and it’s understandable that you want to get it right. But be careful — you could end up spending so much time and energy worrying about the right way to do something that ultimately, you don’t do anything at all. This is called analysis paralysis, and it happens when you overthink a situation and get stuck there. There’s a lot of thinking going on, but very little action. Put an end to that cycle by knowing what financial goals you should prioritize, and why.
There’s no hard and fast ranking of where to put your money that would address every financial situation, but you can start with this simple guide to ease out of feeling overwhelmed, and transition to feeling empowered and capable of taking action.
Build an emergency fund
Having an emergency fund is absolutely critical to your financial success. It gives you a buffer in the event something significant happens financially that you can’t quickly come back from. Some of these things include:
- Job loss. If you lose your job, you lose your paycheck and your medical benefits (unless a spouse has you covered there). This can put a severe dent in your finances—so much so that you may have to sell your assets and dramatically adjust your lifestyle.
- Home repairs. Owning a home is great, but it comes with costs. When your furnace breaks or your roof begins to deteriorate, you’re going to run into some high, unexpected expenses.
- Medical emergencies. You can’t always plan for these, but they can cripple your finances.
- Car problems. If you’re someone who likes to drive your car until it doesn’t go anymore (frugal move, by the way), then you’re bound to have some car problems. Having money set aside for these significant expenses is essential.
- Pets. Anyone with pets knows that they can get crazy expensive. Not only are you shelling out money each month on food and natural needs for your pet, but eventually your pet will have issues that need to be resolved. Vet bills can be costly, and getting your dog groomed isn’t always cheap. And sadly, when it comes time to put your pet down, the costs don’t suddenly evaporate.
- Unexpected travel. While unexpected travel expenses may not amount to tens of thousands of dollars, you may need to book a flight unexpectedly—such as when a family member passes away, and you have to travel across the country overnight on a whim.
There are all kinds of things that can happen to you financially, and if you’re not prepared, you can put you or your family in a lousy situation moving forward.
Pay Off Debt
Before you start paying off your debt, you should find other ways to reduce it. If you have high-interest credit card debt, do a balance transfer onto an account with a 0% offer. See if you can refinance to get a lower interest rate for your other debt, including car loans, mortgages and student loans.
If you refinance, make sure that your new loan doesn’t extend your terms. The longer your loan, the more you’ll pay in interest. You should use the refinance as an opportunity to save money, not spend more of it.
Keep making the same payments you were previously. Doing so will shorten how quickly you pay off your debt without forcing you to make any changes to your lifestyle.
Start early and chip away.
- Make a list of debts from the highest balance to lowest.
- Pay off the highest balance credit cards and loans first. Pay more than the monthly minimum on these.
- Continue to make at least minimum payments on the rest.
Once you’ve paid a debt, consider putting that same monthly amount toward retirement savings. (And pat yourself on the back.)
Each month, use your income to pay expenses that you’ve put into your budget first, then dedicate whatever is left to savings or reducing your debt. If your goal is to save three months’ worth of expenses, calculate how much you need to save and how much money you can put towards that goal each month. If you were able to find ways to lower your rates or remove unnecessary expenses you can apply that money towards your savings and investing plan. Here are some tips to get you started.
- Set it and forget it. Open a savings account and set it up so the fixed amount that you determined you can save are pulled automatically into your savings account each month. You could also check with your HR person to see if your employer can automatically take a portion of your paycheck and distribute it into this separate savings account.
- Accelerate faster towards your savings goals. Dedicate any extra money that you receive (raises, bonuses, money gifts) to your savings accounts.
Everyone’s financial situation is different, and taking the steps to analyze yours and to strike a balance between saving and paying off debt will help you get on track to a better financial future in the long run. Paying off your debt will not only bring some relief, but freedom to use that money towards other opportunities.
Getting started on a savings plan may seem counter-intuitive when you’re also trying to tackle your debts, but building these extra funds will help you avoid falling deeper into high-interest debt when life’s surprises happen. Your debts won’t be eliminated overnight and your savings will take time to build, but with a little self-discipline and goal-setting you will be on track to a better financial future.