Savings Accounts Vs. Paying Off Debt

Many people face two distinct but competing goals. If you are saddled with high-interest rate debt, you want to get out from under that debt as soon as possible. At the same time, you want to start building savings and a cushion you can rely on in an emergency. In many cases it is smart to use a combination strategy that allows you to meet both of these vital financial goals.

Interest Rates

When deciding whether it is better to focus on paying off debt or building your savings, the first thing you should do is evaluate the debt you have. The higher the interest rates on your debt, the better the return you will get when you retire that debt. For instance, paying off a credit card with an 18-percent interest rate is the same as getting an 18-percent on your savings. If your interest rates are high, making paying your debts a priority is a smart move. You can put some extra money toward building up your savings as well, but getting rid of those debts should be first on your list.

Emergency Funds

You never know when an unforeseen event like a job layoff or major expense will strike. That is why it is so critical for everyone to have an emergency fund set aside. If you have not built an emergency fund containing three to six months' worth of living expenses, you should make that a priority. If you can transfer just a small amount from each paycheck to an emergency fund, you can start to build those savings. While paying off your debt is important, so is building an emergency fund, and it is a good idea to work on both of those goals. Look for ways to trim your budget, then put some of the savings toward an emergency fund and the rest toward paying down your debts.

Debt Consolidation

If you are saddled with high-interest debt, you might be able to lower your monthly payments and get out of debt faster with a debt consolidation loan. If you are eligible for a debt consolidation loan, you can roll your high-interest credit card debt into that loan, then use any money you save to boost your emergency fund and get started on your investments. Lowering your interest rate can be a huge boon when it comes to getting out of debt, so look at your debt consolidation options carefully when reviewing your debt reduction strategies.

Combination Approach

Instead of deciding between paying off debt and building your savings, you can apply a combination approach to the problem. Getting out of debt is very important, and it can save you a great deal of money in the long run. At the same time, it is also important to develop a long-term strategy for saving and investing, and to build a short-term emergency fund. To combine these two critical goals, you could invest enough in your 401k to get the full company match, and put any extra money toward paying down your debt. Investing in your 401k gives you an immediate tax savings, and you can use those tax savings to help reduce your debt. Once your debts are paid off, you can use any excess cash flow to build your retirement and personal savings.