When you’ve got extra money, you may ask yourself, “Should I save or pay off debt?” Both financial goals have merits, and which makes sense for you depends on your circumstances.
The simplest factor in answering this question is interest rates. Many experts will tell you that paying off debt makes more sense than saving if the interest you’ll accrue on the debt is more than the interest you could earn in a savings account (which is usually the case). Our calculator can help you weigh your options between saving versus paying off debt if that’s the most important factor for you.
But saving versus paying off debt involves other factors, too. A savings account affords you the flexibility to weather emergencies and take advantage of opportunities. Reducing debt impacts your credit score, which may affect a variety of areas in your life.
If you’re trying to decide between saving and repaying debt, here are the pros and cons of each.
Should I Save or Pay Off Debt: The Pros and Cons
Despite the stigma in our culture around debt, paying off debt might not be your highest priority. Building some savings, even while you’re sitting on debt, can keep you secure in case your life’s circumstances change unexpectedly, like losing your job or ending a relationship. Savings can also ensure you’re prepared for opportunities that come with an upfront cost, like a major move to accept a new job or a family event you can’t miss.
Putting extra funds toward savings instead of debt payoff, however, means your debt balance doesn’t shrink much; in fact, it continues to accrue interest and may grow over time. If you hold high-interest debt, like credit cards, that balance can grow pretty fast.
If you choose to save while you have debt, it is beneficial to at least make the minimum payments on any outstanding loans or credit card debt at the same time. That should keep you from incurring late fees and risking the loss of any collateral you’ve put up for the debt, like your car. You may also split your savings between long-term investments and a liquid high-yield savings account so you may access it whenever you need it.
- Build an emergency fund to protect you against unexpected financial circumstances.
- Fund major life transitions, like moving or starting a new job.
- Build a cushion in case you need to leave a toxic situation, like a bad job or relationship.
- Saving as early as possible helps you earn more through compound interest.
- Debt will likely accrue interest at a faster rate than savings will earn interest, keeping your net worth in the negative.
- A lot of debt may negatively impact your credit score and make other financial goals harder to achieve.
Pros and Cons of Paying off Debt Instead of Saving
Debt can cause a lot of headaches for some people, so paying it off quickly might be a higher priority for you than building savings for your future. Reducing your debt may also mean you may accrue less interest, which leads to paying less over the course of repayment. Having less outstanding debt is also likely to improve your credit score, which could be important if you want to apply for a mortgage or even move into a new rental or get a new job soon.
But putting all your extra funds toward debt instead of savings may delay your future goals and financial security. You may not have enough for a down payment on a home, and you could get behind on retirement savings.
If you choose to pay off debt before saving for the future, at least build an emergency fund in a liquid savings account. Many experts recommend banking around three to six months’ expenses in an emergency fund, but just a few thousand dollars could at least give you the cushion you need when life throws you a curveball.
- Smaller debt accrues less interest, so you owe less in the long run.
- Paying debts off on time or early helps you avoid late fees.
- Having less debt will improve your credit score, which could help you achieve other financial goals sooner.
- Not building a savings cushion leaves you vulnerable in case of financial emergencies or unsafe circumstances.
- You may have to forgo or delay major life events, like buying a home, having a child, moving or starting a new job.
- You’ll miss out on months or years of earning compound interest to grow your savings passively.
Still Wondering: Should I Save or Pay Off Debt?
Plug your numbers into our handy calculator to weigh your options. Click here.
Information and interactive calculators are made available to you as self-help tools for your independent use to help you determine how a loan, line of credit, or deposit account may affect your budget and are not intended to provide investment advice. The results offered are estimates and do not guarantee available loan terms, cost savings, tax benefits, etc. Quontic Bank cannot and does not guarantee their applicability or accuracy regarding your individual circumstances. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues.