Currently, with the soaring cost of college tuition, unexpected and expensive life events, rising interest rates, and high inflation, it gets harder to manage money, pay down debt, and save. For those who are overextended, does it make more sense to pay down credit or put money towards saving, or a combination of the two? This is a common question. Well, it depends, say financial experts. That’s because everyone’s set of circumstances are unique.
If you have high debt and no savings, it’s important to have a strategy. You’ll want to cease unnecessary and wasteful spending and create an emergency fund so that basic needs are met in an emergency. Having extra funds “for a rainy day” is helpful. For example, it’s beneficial to have money saved should you lack insurance coverage and a trip to the ER becomes necessary. However, emergency funds should be spent wisely and not be used for vacation or other frivolous expenses. Tracking and categorizing monthly expenses are key to separating wants from needs and determining what you can and can’t live without. Experts suggest having six months of expenses saved up. This can aid in paying rent, buying groceries, and making automobile payments and the like, should one become temporarily unemployed or unable to work. However, six months might be a stretch for some folks. If that’s the case, try for three months and build up savings as you are able.
Most finance experts agree that it’s vital for people to save money for short term (eg. emergency) and long term (eg. retirement) goals. While it’s optimal to start retirement savings when young, it remains a good idea to begin ASAP regardless of age. The reality is that many people’s retirement fund contributions may suffer for a variety of reasons. Perhaps it’s due to high college tuition payments paid by parents to support children in college, rendering them unable to save for retirement. Funding one’s retirement ensures that a person can live comfortably in their golden years with reduced hours of work. Note that while a student’s education is important, many finance professionals advise that it is not worth sacrificing retirement funds to pay for education. Thus, it’s best to discuss an action plan and seek financial balance if needed, perhaps helping but not assuming the full financial load. Experts factor in that people are living longer and thus will need substantial savings to retire comfortably. They also recognize that earning and saving potentials decrease with age. Per the College Investor, “As a parent, you can’t get a loan for retirement…” and if you have loans and no savings, you may unwittingly become a financial burden on your children.
Failure to save for emergencies or retirement due to overspending or poor money management practices can occur. However, it is never too late to be wise with money. Getting back to the main question, to pay down debt or save, Equifax, one of the three credit bureaus in the U.S., explains that after creating an emergency fund, there are two main strategies to pay off debt. The first is called the snowball method, in which a person lists debts by total amounts and begins paying off the smallest one first and works their way up to the largest expense – while still paying minimum balances on remaining debt. This is preferred by some people due to the positive and psychological benefit of reducing the number of creditors or to the party to whom money is owed. The second is the avalanche method, whereby people rank their loans based on interest rates rather than by dollar amount and focus on paying off the balances with the highest rates first – also while continuing to pay minimum balances on the rest of their debt. Either way, some money is paid toward reducing debt.
Better money habits are key to achieving financial goals of saving and reducing debt. Since payment history is among the most influential factor for FICO and other scores, you’ll want to make sure that bills and debts are paid on time as per your agreements. You’ll immediately want to cut unnecessary spending, start an emergency savings, and review finances to determine which method is preferrable to pay down debt. If you’re employed, take advantage of 401k or other helpful plans that can benefit retirement. Additionally, note that every financial condition is unique, so one answer does not necessarily apply across the board. Thus, when in doubt, it is likely best to seek the advice of a trusted accountant, CPA, or professional financial advisor to determine your best actionable plan.
Disclaimer: This information is not intended as specific financial advice. It is for informational purposes only.
Sources:
The College Investor (Should parents pay for their children’s college education?)
www.equifax.com (Should I pay down debt before saving money?)
www.statnews.com
www.thebalancemoney.com (Rule of thumb: How big should your emergency fund be?)
www.wellsfargo.com (How to calculate your expenses)
