If you haven’t weren’t raised with a good understanding of finances, it can feel really overwhelming when you find yourself in a tough financial spot. One of the major questions everyone asks is, “Should I save money or pay off debt?” In this post, we’re going to break down just how you should handle your debt and savings and which one you should tackle first.
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The quick breakdown
Alright, before I dive into all of the details, let me break down for you real quickly what your options are when it comes to either saving money or paying off debt.
- Save at least $1,000 emergency fund
- Put at least $200 toward your smallest debt with the Debt Snowball method
- Replenish your savings when you need to use any funds
- Automate small amounts to your savings to cover emergencies over $1,000
I’ll cover each of these areas and share a little bit more about why you should consider putting more money toward debt while still boosting your savings a little.
Calculate your debt
The first and most important thing you need to do is look at how much debt you have. This might require some work on your part. A lot of people don’t actually realize just how much debt they have.
Not knowing your debt makes it impossible to create a solid plan for debt payoff.
What is considered debt?
Debt is considered anything that you are making payments on. This goes double for things that you are paying interest on.
You are in debt if you have things like:
- Credit card bills
- Car loan
- Student loans
- Doctor bills
Anything that you haven’t paid in full and are making payments on falls into the category of debt.
The only one of these debts that we will not be focusing on is mortgage debt. Out of all of these, a mortgage is the only debt that can prove to be beneficial to you because it will most likely only increase in value and therefore make you a profit. Although there are different opinions on this topic.
Is your credit in trouble?
Having a lot of major debt that you are struggling to pay off could be seriously affecting your credit score. If you think you are in need of credit repair help, grab this free eBook and credit consultation.
To start calculating your debt, you are going to need to come up with 3 separate numbers:
- The total amount owed
- Amount of your monthly payment
- What interest you owe on each debt
Consider your current savings
Often times people with a lot of significant debt have already worked to build up safe, secure savings. This is a great idea, but consider that you have $10,000 in savings and a $10,000 outstanding credit card balance.
Continuing to make your monthly payments will cost you $372 per month and (according to this Credit Karma calculation,) almost $3,400 in interest.
Using savings to pay off debt
So what if you took that $10,000, paid off your debt, and instead put that $372 minimum into savings like the Savings Builder savings account?
In three years instead of having lost over $3,000, you’ll have made almost $4,000 in compound interest according to Bank Rate’s simple savings calculator.
What if I don’t have any savings?
So maybe you’re saying to yourself, “that’s great, but I don’t even have $100 saved let alone $10,000.” –It’s all good.
If you don’t have savings in place for yourself yet, before you begin paying off any debt the first thing you need to do is build a secure, $1,000 emergency fund savings.
While I love the Savings Builder savings account because it pays you to save, for your $1,000 emergency fund, I recommend keeping this saved at your local bank for easy access during emergencies.
Building an emergency fund
Having an emergency fund in place before you begin a debt payoff plan is crucial.
Let’s face it…something is going to go wrong. Some emergency is going to present itself and you don’t want to be left penniless. You also don’t want to feel so stuck that you turn to a credit card to help you out of the situation.
Pay off debt
So, when you are done building a solid emergency fund, it’s time to tackle debt.
Having debt is like a life sucking pain in the butt. Let’s get down to the basics of why is really stinks:
- You end up paying more the longer you have it.
- It takes money away from you every month.
- It can ruin your credit score.
- Prevents you from living the life you want.
- Prevents you from building secure savings.
When it comes to debt payoff, there really is no wrong way to do it. As long as you do it. There are, however, different expert opinions on how to tackle debt the right way.
- Build an emergency fund
- Find an additional $200 in your budget
- Halt all other savings and investments (including 401K).
- Begin your Debt Snowball (Check out our Debt Snowball post to get more details and a free printout.)
Debt Snowball How to Video
Nervous about not saving?
Some people are quick to turn away from Dave’s methods because the idea of not saving it too scary. When it comes to this, there are basically 2 schools of thought:
- The faster you pay off debt, the more money you will have to save/invest
- Continue putting $200 or more toward your debt each month, and set up a small recurring monthly payment to a savings account. See the best online savings option.
During debt payoff or savings, there will no doubt be times of struggle. It’s so important to remember to keep going. Every little bit adds to the big picture.