It is quite challenging to choose between paying off debt or saving before. Are you stuck amidst this question " Pay off debt before or Save?"
Well, you will know the answer by the end of this article. This article explores various factors to decide which is the better and prior option amidst paying or saving.
Include these 7 factors in your decision- making strategy :
1) Interest cost versus Interest Earned
" Cost of the debt in competition with the interest that is earnable on the same amount if saved " – is one of the leading factors in decision-making.
In such a case, you need to determine the net financial rate on the reduced interest versus the savings and its interest.
You will have an option to split your extra income into two sectors. One toward debt and the other towards savings.
2) Check on your job situation
Is your job secure? If no, then prioritize saving before paying off debt. Why? Because, if you pay down debt and lose your job simultaneously, you are left with no money. You will automatically shift to card use and this will lead to added debt.
The worst factor of the situation is you land up somewhere between a lower-paying job and increased debt rates.
Henceforth, prevent too much card use, rather shift on savings that might be helpful in the paying off of the debt.
Why I'm suggesting not to pay off debt with a credit card is any credit card company might reduce your current credit limit.
3) Calculate your Emergency Savings
To determine your savings, follow the general rule stated by many credit counselors. The rule states – " Divide your annual income by $10,000."
The resulting figure post- division is the number of months of living expenses you will require in the savings until you have the next job at equal pay.
Suppose you draw on savings every month; instead of contributing revisit your budget this month. By which I mean to reduce your monthly contribution and shift the focus to the management of expenses with available income.
4) Eliminate the toxic debt first
After the establishment of your basic savings, focus on paying off unsecured debts which include payday loans, credit card loans with higher interest rates (15% and more), car-fetching loans, etc.
These debts require prime focus because their interest rate can adversely affect your budget in the future, resulting in a spiral debt.
Use tools like 'debt snowball' to pay off your debts faster.
5) Balance extra savings and leftover debt
Once your toxic debt is under control, start focusing on building extra savings. You can do this savings while paying off the leftover debts.
You might be confused about how to save for the future or post-retirement. It is simple, work up to save 15% of your gross income. And if your company does not have any such policy, switch to an individual retirement account. You can manage a faster debt pay-off by cutting extra expenses from your budget or work up an extra hour for some extra cash. This way, you can balance extra savings and leftover debt simultaneously.
6) Apply any one of the two formulae if you are about to receive a potential windfall
If you already have some savings with you, stick to the below-mentioned points and pay off an easy emergency fund. Keep only 30% of your windfall for basic needs. Next, invest 25% on the extra savings for paying down leftover debt. Invest 20% as your savings. Fix 15% of your windfall for long-term investment and the leftover 10% for self-fun.
If you do not have to pay an emergency fund stick to this chart. Spend 35% for emergency savings with 30% for basic needs. The 25% of your windfall should be invested for cutting down debt. Leftover 10% for self-help purposes.
7) Get help from a counselor
I've suggested 6 ways to choose between Pay Debt Before or Saving Before but, if you are still confused, meet a non-profit credit counselor. He will give you free and confidential help.
Whether it is choosing between paying off debt, saving money, or a proper balance between the two, a counselor can help you out.
The earlier you contact a credit counselor, the faster you will reach your financial goals.
Conclusion
Thus, as the concluding sentence, I would suggest you pay off your debts before you start saving. As of you will get a rate amount of interest on your savings that can be very well utilized in the pay off on your borrowings. I hope by now, you can hold on to this confusing situation and take a clear – cut decision .
