Saving Money Vs. Paying Off Debt: Which Is More Important?

saving money vs paying off debt

Saving money vs. paying off debt: The debate is always raging. When you have to make the choice between blasting through debt and establishing precautionary funds in case of a financial emergency, the right course of action is rarely self-evident.

Debt can be a heavy burden detrimental to your present and future financial options. But without emergency funds, you risk plunging deeper into debt should a costly crisis arise. The truth is, how you allocate your money is contingent on a number of personal circumstances. There is no single correct answer to satisfy everyone’s needs.

Related: How to Successfully Save a $1,000 Emergency Fund

There are two primary factors to consider when choosing the smartest route: Type of debt and susceptibility to disaster.

Type of Debt

Some debts are nastier than others. Credit card debt has earned a reputation for being a particularly cantankerous beast. With interest rates often exceeding 15%, credit cards can wreak havoc on your finances and credit score.

If the bulk of your debt stems from unpaid credit card purchases, you’ll probably want to start by paying those bills. Credit cards have much higher interest rates than savings accounts, so making savings deposits will do little to counterbalance the negative impact of your debt.

One exception is if you can get ahold of a credit card with a 0% purchase and transfer APR introductory period. If you’re not being charged interest, you might be able to take a little time to create an emergency fund before tackling your debt.

Related: When Should I Do a Balance Transfer?

Student loans and mortgages are another story. They generally charge interest rates significantly lower than credit cards, so a dollar of student loan debt costs you less than a dollar of credit card debt over time. And as long as you’re making your regular payments, “installment debt” actually helps your credit score.

Lenders fear excessive credit card usage, but admire people who have the persistence to pay off mortgages and student loans. You don’t need to rush yourself — make the minimum payments and use additional money to establish an emergency fund.

Susceptibility to Disaster

Some people just have all the bad luck. If there’s little black cloud hanging over your head, you’ll appreciate the security an emergency fund can offer. With an emergency fund, you’ll avoid incurring further debt should you need financial support during a crisis.

While we can never predict the future, we can look at our circumstances to determine the odds of suffering a financial disaster. Here are a few factors to look at when weighing the importance of an emergency fund:

  • Job security. If your job is unstable or under threat, you should be prepared for unemployment.
  • Family. How many people do you support? The more dependents you have, the more lives a mishap will affect.
  • Housing. Do you rent an apartment or own a house? If the hot water tank needs to be replaced or a tree falls through your roof, will you be responsible for paying the damages?
  • Transportation. A person who drives an hour to work every day is far more likely to pay for car repairs or traffic tickets than a person who takes public transit. Further, every vehicle you add to your family multiplies the odds of unforeseen auto expenses.
  • Health. Bad health is expensive and often unpredictable. How likely are you or your family to incur medical bills? How much will your health insurance cover?

Related: 6 Simple Tips for Growing Your Savings Account

A person who fears for his job, has eight kids, owns an old house in a rough neighborhood, drives a beater to work and has been in and out of hospitals for the past decade should probably have a larger emergency fund. A person who is firmly rooted in a secure and promising job, is single and child-free, rents, walks to work and rarely requires so much as an aspirin could be okay with a much smaller emergency fund.

When it comes down to it, you have three options:

  1. Pay off your debt and forgo the emergency fund
  2. Wait to pay off your debt until you’ve established an emergency fund
  3. Work on both simultaneously

If you have heavy credit card debt, focus on paying it off. If your life is fraught with financial risk, focus on establishing an emergency fund. If you have both credit card debt and a high probability of catastrophe, divide up your money and work toward both goals simultaneously. It’s a little like gambling, but if you know the odds, you can minimize your losses.

  • I’m a big fan of the saving and paying off debt simultaneously plan. It’s important to keep an emergency savings fund, something that most people don’t have. Paying off debt at a quicker pace will allow you more freedom once everything is paid off.

  • Gene

    It almost seems like it’s impossible to both save AND pay off expenses at the same time. Hey, I can pinch a nickel till the buffalo poops — but that savings account ain’t getting any bigger.

  • Meredith DeGaulle

    Save money to pay off debt. Do both at the same time. Here are some tips:

    1) drop the smart phone and get a “dumb” one. Save about $50 per month. Get a low-priced tablet (e.g., Kindle Fire) or use your old iPhone as a wi-fi only device. Wi-fi is available everywhere; you really don’t need to pay for cell-based data plans

    2) call your car and home insurance company and tell them you want to go through all your coverage because you found another carrier that is cheaper. They’ll probably help you “find” 10% off or more.

    3) speaking of car insurance – An expensive policy from GEICO, Progressive, etc. is not needed. You can find one usually for less than $25/month from a place like Insurance Panda. If you spend too much on car insurance from one of those big companies, chances are you are simply funding their expensive TV ads with cute animals.

    4) compare what your house is really worth to your assessment. Many assessments have never been properly adjusted down to reflect the market over the last 4 years. We cut our property taxes by about 20%.

    5) re-fi your 30-year mortgage to a 15. The interest rate will drop by at least 50-75 bps, more depending on your current rate. The payment may go up slightly, but it is because you are paying off your loan faster. If it’s possible, get the mortgage paid off before the kids go to college. At a minimum, have it paid off before you retire.

    6) review your credit card bills for all the things you are paying $10-20 per month for that you no longer need. I bet everybody has at least a couple

    7) drop all magazine (paper and on-line) subscriptions. If you look around, you can find comparable content for free.

    8) review your investment portfolio for ways to replace higher fee mutual funds or ETFs with lower fee ones. S&P500 funds/ETFs shouldn’t charge more than 0.10% in fees. Fees may be higher for specialty funds, but they are all coming down fast. If your company 401K uses high-fee funds, talk to the folks in charge. A difference of 25 bps in fees will mean a difference of about 5% in your portfolio value after 25 or 30 years.

    9) and of course the most impactful — never carry a balance on a credit card. If you can’t resist, cut up the cards.

  • fpleti2

    What really needs to be thoroughly considered is your level of risk exposure to a particular strategy.

    For example, you can purchase a minimum coverage ($50,000 liability) auto insurance for ~$25/month. However, if you own your home or have equity in it and have assets in the bank, one serious accident (no matter who is at fault) will place you squarely under the cross-hairs of a lawsuit. So this may not be a good strategy if you drive more than an hour one way to work.

    If you use your Kindle etc for purchases or banking it would not be a sound strategy to take it to WiFi hotspots to avoid the monthly internet fee as these locations harbor the predatory hackers just looking to hijack your bank account and credit card information which are resident on your Kindle. So, yes you can save money by doing so, but your exposure to fraud is high.

    Looking at your home’s assessed value to its actual worth is a sound strategy albeit only temporary i.e. a year or two at most. If more than 10% of the properties in your taxing jurisdiction get downward adjustments, the taxing body will simply adjust the multiplier up to make up the difference. Net net the same tax cost to you.

    The strategy of re-financing your home depends on two factors, what your interest rate is and how long you have to pay it off. Generally if you can get a 2% reduction in interest and have at least 15 years to go on the loan it makes sense. Where it gets tricky is when you have a high interest rate that you have been paying for 20 years on a 30 year loan because now most of your payment is going to principle not interest and re-financing just restarts the payment clock with most of the new payment schedule going to interest not principle. If cash flow is the primary issue it makes sense to re-finance no matter where you are in the loan and extend the loan out for 30 years i.e. you don’t pay it off but significantly reduce your monthly payment by 50% or greater.

    Depending on where you are in “the financial crisis cycle,” beginning – job secure planning for future, middle-job insecure planning for worst case, end – no job looking to stop financial free fall will dictate your strategy.