Should You Pay Off Debt or Save Money?

Have you been blessed with some “extra” money such as a year-end bonus, freelance earnings or an unexpected gift? If so, you may be wondering what to do with it. Obviously, you could save it, splurge or pay off debt. One of the most common debates is the savings-versus-debt debate. But if you answer the following questions, you should be able to decide which one would make the most sense for you.

Do you have an emergency fund?

First, do you have an emergency savings fund? Even if you have credit card debt with high interest rates to pay off, you need to have a savings account to handle emergencies. An emergency can occur at any time. You might find you need to get your car’s transmission replaced, a root canal or a dishwasher repair. Credit is tough these days so you can’t just count on getting a new credit card or other types of loans to bail you out. You need to have your own cash stash for those types of emergencies. In fact, you need have at the at the minimum three months’ worth of expenses put away.

How much is your debt costing you?

You need to also determine how much your debt is costing you. This is a very simple calculation that many people don’t make but can show you just how costly debt is. The way you determine the cost of your debt is to list of all your loans, including your mortgage, auto loan. credit card debts and any other form of debt. Next to each loan amount write down the interest rate you’re paying. Then multiply the two numbers. This is how much you’re spending on each loan per year. For example, a $12,000 car loan at 6% costs about $720 a year. Remember that figure as we move to the next question.

How much might you earn?

Next, determine how much you would earn if you were to save this new found cash and where would you put it? Would you deposit it in a bank account that’s earning, say 1%? Or would you put it in a money market fund that would earn more? In today’s economy, it’s tough to earn more than 1% or 2% without opting for a risky investment. Get a piece of paper and write down the amount of your “extra “cash and then multiply this number by the interest rate you think you would earn on that money.

Compare the two

Now, compare the cost of your debt versus how much your savings would earn. Consider whether paying off a piece of your debt could earn you more money than you would get if you were to save it. If paying off part of your debt would save you more then saving the money, it might be better to pay it off.

Think about your future earnings

Do you think you might get more of this “extra” money in the future? If you believe you might get another boost like this, you would have somewhat more flexibility because you would have more money to work with and might be able to both pay off debt and save money.

Your financial goals

Do you have plans that would require a lot of cash? Do you intend to start your own business, trek through the Himalayas or buy a home? In this case, it would probably be best to increase your savings so you would have more than only an emergency fund. However, paying off debt can also help because it allows you to begin your new adventures without having to carry the weight of old loans.

If your debt is out of control

Of course, if your debt has gotten out of control, all of this is somewhat academic. You need to tame that debt and this is where we can help. Our counselors can work with your creditors to get your debts reduced – probably by thousands of dollars – and help you get out of debt within a reasonable amount of time. Call our toll free number to learn more about debt settlement and how it can help you. It’s an easy call to make and could make a huge difference in your life.