One of the most common financial dilemmas individuals with debt face is whether to pay off that debt first or save money. While there is no one-size-fits-all answer to this question, understanding the factors involved can help you make the best choice for you.
Read more: How to use Ally Bank’s buckets and boosters to get your finances in order
Understanding your financial situation
It’s important to analyze your current financial standing before deciding whether to save or pay off debt first.
Assess your debt
The first step to taking control of your debt is understanding it. By assessing how much you owe compared to your income, you can use DIY strategies, like the snowball method, or debt relief options, like a debt management program.
Evaluate your savings
Do you have enough savings? That can depend on multiple factors, including your age, spending habits and financial goals. Building an emergency fund is also important, as it can help shield you from unexpected expenses, job loss or medical emergencies.
By assessing how much you owe compared to your income, you can use DIY strategies, like the snowball method, or debt relief options, like a debt management program.
Is it better to pay off debt or save?
Ideally, you would do both. But if that isn’t an option, consider the following:
Interest rate: Credit card debt and high-interest loans can accumulate interest at rates that far exceed what you can earn on a savings account.
Emergency fund: As a general rule, you should have three to six months’ worth of living costs in your emergency fund to help cover essential expenses like rent, groceries and transportation.
Financial goals: If you have dreams of owning a home, paying for your child’s education or retiring early, you’ll likely need long-term savings to achieve them. Eliminating debt can also allow you to direct more money toward your financial goals. Consider which goals are the most important to you and your future.
Benefits of paying off debt first
Debt reduction not only frees up your financial resources but also alleviates the emotional stress associated with financial obligations. Moreover, it can improve your credit score, leading to better loan terms and financial opportunities in the future.
Advantages of building savings first
Savings can be viewed as an investment in your future financial stability. Without a healthy savings buffer, you could find yourself taking on more debt when faced with unforeseen financial challenges, potentially undoing the progress made in debt repayment.
Strategies for balancing debt repayment and savings
While not easy, it’s not impossible to pay off debt while still saving. These strategies can help you manage both.
Debt strategies
Get your debt under control with these methods:
Snowball strategy: Pay off your smallest balance first and then roll the amount you had been paying to your next smallest debt and so on. (Picture a snowball gathering mass and speed as it rolls down a hill.)
Avalanche: Pay the minimum balances on each debt and put any extra income toward the balance with the highest interest rate. Once it's paid off, direct your payments to the balance with the next highest interest rate and so on.
Debt consolidation: Manage debt from multiple sources with varying rates by consolidating debts into one monthly payment.
Debt management: A professional credit counselor, debt consolidation company or debt relief program can help you negotiate more time or better rates, manage or consolidate your debts or pursue debt settlement.
Savings strategies
Whether you’re working toward building your emergency fund or saving for a down payment, here’s how you can get started on the right path:
Budget your income: The 50/30/20 method divides all your expenses into three categories, with 50% of your monthly income going to needs, 30% to wants and 20% to savings and debt repayment.
Automate your savings: With an Ally Bank Savings Account, you can set up recurring transfers to move money into your savings on a schedule that makes sense for you.
Organize your account: Creating separate buckets to divvy up your money can help you contextualize your savings and motivate you to save more.
The importance of a balanced approach
Whatever choice you make when it comes to paying your debt off first or saving, the key is finding the right balance that supports your goals. Remember, managing your finances isn't just about restrictions, it’s also about achieving a well-rounded life.
