Paying off debt and saving money are both great things to do for your finances. But should you be doing one instead of the other? Today we're going to talk about which is best for you. Want to read more about paying off debt v. saving? Read our post here:
When it comes to making this decision, there are two approaches. The mathematical approach and the emotional approach. The mathematical approach says that you should put your money to wherever it will work the hardest for you. The emotional approach to answering this question is a little different. Many people have a negative emotional reaction to being in debt. Therefore, they decide to tackle the debt first.
While there's not a right or wrong answer to paying off debt or saving, we do have a step-by-step plan we would recommend for people who have debt but want to start saving for the future.
Step 1: Put Your Maximum Matched Savings into a 401(k)
If you have an employer who matches your 401(k) contribution, your first step is to put as much as they’re willing to match into that account every single month. For example, if your employer matches up to 2%, then you get a 100% return on 2% of your salary. That’s free money for your future!
Step 2: Build an Emergency Fund of Savings
If you’re wondering whether to pay off debt or tackle your emergency fund first, the answer is to build an emergency fund. The last thing you want is to have to turn to credit cards and take on more debt if you have some kind of emergency like a medical bill or car repair.
Step 3: Focus on Paying Off Debt with High Interest Rates
Now that you’re contribution to you 401(k) and have a small emergency fund, turn your attention (and your excess income) toward your debt. Any debt you have with subprime interest rates, or rates higher than 9%, is first to go.
Step 4: Decide Your Savings And Debt Priorities
At this point, your finances are in pretty good shape! You have an emergency fund and you’ve wiped out any high-interest debt. So should you pay off debt or save more at this point? It’s up to you now.
Step 5: Stick To Your Spending Plan And Keep Building Your Savings
Personal finance is just that. It’s personal! You don’t have to dedicate all your extra income to paying off your debt or saving. You can do both.
At the end of the day, the decision to pay off debt or save money is a personal choice. Everyone’s situation is different and you have to do what’s best for you. The key takeaway is to figure out what makes mathematical sense for your situation as well as what aligns with your saving goals and values. And from there, you can make an informed decision for your finances.
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