Expert Advice: Should I Save or Pay Down Debt?
By Carla Fried
- PUBLISHED August 08
- 4 MINUTE READ
Building financial security can sometimes feel like a bit of a juggling act. As much as you focus on how to save money, you might also be carrying some loans and credit card balances that you know you should whittle down as quickly as possible.
In most cases, paying off debt before you start to save money is the smart move. That’s because the interest you’re paying on your loans is almost always more than the interest you can earn in a savings account.
For instance, the average interest rate charged on credit cards was around 15% in early 2018, according to the Federal Reserve. That’s about 10 times higher than the rate you can currently earn on a top-notch high yield savings account.
That said, there are a few scenarios where saving may make more sense than focusing solely on paying off debt.
The first is when you have little or no money set aside in an emergency savings fund. According to a national survey, about 6 in 10 Americans say they don’t have cash tucked away that they would use to pay for a $1,000 emergency, such as a car repair or medical bill. Creating that emergency savings fund may be one thing you should consider prioritizing over paying off debt.
The second legitimate reason to save instead of paying off debt is when your employer will match your contributions to a company retirement plan. In many workplace retirement plans, such as 401(k)s, if you contribute to the plan, your employer will kick in some money too. That is a deal you may want to take advantage of, even if it means paying off debt more slowly.
Another thing to consider is what kind of debt you have. Student loan interest and mortgage interest are often tax deductible, so they there may be advantages to maintaining your monthly payments rather than paying them off completely. Check with your tax professional to find out.
The last reason may come up if the rate you pay on a loan is lower or comparable to what you could safely earn in a high yield savings account, money market account or certificate of deposit. In these rare instances, it may make more sense to save rather than pay off that debt immediately.
At the same time, you should also take into account your own feelings toward debt and what you need to have in the bank to feel comfortable. Would having some savings make you feel more secure, regardless of whether it makes financial sense? That’s an important factor to consider when making a financial plan.
This chart is a checklist. The title is “When You May Want to Focus on Saving.” There are three items on the list. The first is “When you have little or no money set aside for emergencies.” The second is “When your employer will match a portion of your contributions to a retirement plan." The third and last is “When the interest rate you can safely earn on savings is more than the interest rate you are paying on your debt.”
Carla Fried is a freelance journalist specializing in personal finance. Her work appears in the New York Times, Money magazine, Consumer Reports and CNBC.com.