Should You Save or Pay Off Debt First?
Should I focus on saving money first? Or should I work on paying off debt?
If you’re asking this question, you’re probably hoping for a clear rule. Something like: save $1,000, then pay off debt.
Unfortunately, it’s not that black and white.
But there is a helpful starting point.
In most situations, it makes sense to have at least some money in savings before paying down debt.
Why?
Because life is full of unexpected expenses. Your car needs repairs. A pet needs surgery (wondering if pet insurance is a waste of money?). Your kid needs braces.
If you have no savings when those things happen, the expense usually ends up on a credit card. That can make it even harder to get out of debt.
Saving first also helps build the habit of setting money aside, which is something you will want to keep doing long after the debt is gone.
So let me reframe the original question:
How much money should you save before shifting your focus to paying down debt?
Here are the factors I look at with my clients to help them arrive at the best decision for them. Feel free to jot down your numbers and follow along!
Factors to Consider When Deciding How Much to Save Before Paying Off Debt
Let’s start by taking a step back and gaining awareness of your full financial picture.
Gather this info:
Your income
Your average monthly expenses
Your total debt balances
The type of debt you have (e.g., credit card, student loan, etc.)
Interest rates on that debt
How much you already have saved (exclude retirement accounts, since there’s usually a 10% tax penalty to withdraw that money early)
Once you have that information, we can move on to the next step.
1. Are You Spending More Than You Make?
Before switching from saving to paying off debt, it is important to make sure your foundation is solid.
If you are spending more money than you make, you cannot make meaningful progress paying down debt.
The numbers simply will not work. Or as I like to say, the math doesn’t math.
In those situations, the first step is usually understanding where your money is going and making adjustments so that spending fits within income.
Once that is in place, debt payoff becomes much more achievable. And you’ve significantly increased the likelihood that you’ll stay out of debt once you pay it off!
2. Does Your Income Change From Month to Month?
Income stability also plays a role in deciding how much to save first.
If your income is consistent each month, it may feel safer to shift toward paying down debt sooner.
But if your income fluctuates, it becomes more important to look further ahead before making that pivot.
For example, imagine a realtor who receives a large commission but may not get paid again for several months.
Using that entire commission to pay down a credit card might feel great in the moment. But if the next few months of rent and expenses are not already covered, you’ll probably regret it in 30 days. I want you to make permanent, not temporary, progress.
Planning ahead and projecting your expenses over the next several months can help you decide how much of that money should stay in savings before sending extra toward debt.
3. What Type of Debt Are You Paying Off?
Alright, you’re bringing in more money than you’re spending (way to go!) and are fairly confident you’ll be able to cover your expenses for the next few months, so now we can start looking at your debt more closely.
What type of debt do you have?
Credit card debt is usually something I encourage clients to address more aggressively because the interest rates are often very high, typically somewhere between 20% and 30%.
At those rates, interest adds up quickly.
For example, if you have $10,000 of credit card debt at a 25% interest rate, you’re paying about $2,500 in interest each year. No one wants that for you (except the credit card companies)!
Other types of debt, like mortgages and student loans, likely have lower interest rates and may also come with certain benefits.
For example:
Mortgage and student loan interest may be deductible on your tax return
Some student loans qualify for forgiveness programs
For debt with special factors, there is a higher bar before we pay those down beyond the monthly minimum.
4. What Is the Interest Rate on Your Debt?
Interest rate is closely related to the type of debt, but it is worth looking at separately.
Generally speaking, the higher the interest rate, the more urgency there is to start paying it down.
If the interest rate is lower, it may make sense to build more savings first.
5. What Gives You Peace of Mind?
Finally, there is one factor that is often overlooked in financial advice.
Your comfort level matters.
When I ask clients what amount of savings would help them feel secure (at least in the shorter term), the answers vary widely.
For some people, that number might be $5,000.
For others, it might be one month of expenses.
What is your gut telling you about what level of savings would give you peace of mind?
Why There Is No Universal Rule
A lot of online advice tries to turn this decision into a simple formula.
You might hear things like: save $1,000, then pay off all debt.
But every person’s financial situation is unique.
Saving $1,000 might feel sufficient for someone who pays $500 in rent.
But for someone paying $4,000 per month in rent, that same amount may not feel like much of a safety net.
Personal finance decisions are personal. Your decision should account for things like:
Your expenses
The consistency of your income
The interest rates on your debt
Your financial goals
Your comfort level
The right answer depends on the person.
Are You Stuck Choosing Between Saving and Paying Off Debt?
If you are trying to decide whether to save money or focus on debt, it is worth remembering that either choice moves you forward.
In both cases, you are doing something to improve your financial situation.
So take the pressure off yourself to find the “perfect” answer before you start taking action.
After looking at these factors, pick the approach that makes the most sense for you and then get to work.
If you want support navigating this decision, this is exactly the type of thing I help my clients with during a Clarity Session!
Schedule your free call to learn more about how a Clarity Session can help you achieve your financial goals more quickly.
