Should I Pay Off Debt First or Save?

Your financial situation can help you decide whether you should pay off debts before you start building up your savings. You should consider the interest rates you're paying on various credit and loan accounts and also consider saving cash to cover emergency expenses to avoid creating more debts.

High-Interest Debts

You might want to focus on paying off debt before saving if you have credit card debt and personal loans other than home or student loans. Credit cards and personal loans usually come with high interest rates, unlike home and student loans. Retirement and savings accounts generally don't deliver double-digit interest earnings that outpace credit card and loan charges. For example, you may only be earning 1 percent interest on money in a savings account while paying 20 percent or more annually on credit card interest charges. In such cases, you would save more money over time by paying off high-interest debts.

Savings Plan

Bankrate notes in its article "Should You Pay Debt Before Saving?" that some financial advisers, such as Sarah Place of Place Trade Financial, don't recommend paying off debt before saving money for emergencies and retirement. Emergency funds can be particularly important to you during an economic downturn in which you lose your job or have your working hours reduced. Furthermore, people who work for companies that match their contributions to retirement accounts are essentially turning down free money if they don't take the matching funds to bolster retirement savings.

Debt Traps

Other financial advisers cited in the Bankrate article, such as financial author Paula Langgoth Ryan, recommend saving money and paying down debt at the same time. In such cases, you could set aside small amounts of money in a savings account for emergencies while paying down debts as much as possible. People who don't create even a small emergency fund are likely to continue racking up debts. That's because people who don't have cash on hand usually resort to using credit cards to pay for emergency expenses.

Setting Goals

You could concentrate on saving before paying off debt for short periods of time. In such cases, you should set a goal to save a certain amount of money for an emergency fund, such as $1,000. After you reach your goal, you could focus entirely on paying off debts. In the meantime, your $1,000 emergency fund would provide a cushion for unexpected expenses that could help you avoid using credit cards to cover such costs. However, it's important to replace your emergency funds as needed to maintain a $1,000 balance in your savings account.