When Money Is Tight, Should You Pay off Debt or Put Funds into Your Savings Account?
When you're short on cash, you may be unclear as to what direction your financial goals should take. Is it better to take any windfalls you receive and add them to your savings account, or should you focus on paying down your debt? Here are a few things to consider when deciding.
The Interest Rate on Your Debt The interest rate on your debt is one of the first factors you need to examine. If you have a lot of high-interest debt, like credit card debt and unsecured personal loans, your interest rates are typically higher than if your debt primarily consists of student loans or secured loans (such as a vehicle loan). Thanks to the high interest rates, you'll lose money by diverting it to your savings account instead of expediting your debt paydown.
For example, assume you have $15,000 in credit debt at 13% interest. Your current payment will pay your debt off in 5 years. If you can free up $100 in your budget, sending this money to your credit card will save you $13,750.26 in interest.
Now, assume your $15,000 debt is at 3% interest. Sending an extra $100 a month will save you $1,959.58. These savings aren't nearly as substantial due to the lower interest rate.
Your Access to Credit If an emergency pops up, you need money to deal with the associated expenses. Individuals who have access to large credit lines or credit cards with low balances can use their debt to handle these unexpected costs. Since they have access to untapped credit, they can send any extra money in their budget to their debt instead of their savings account.
However, if you have bad credit or maxed out credit cards, you may not have such easy access to credit in an emergency. You don't want to have to take on high-interest debt in order to cover unanticipated expenses. Instead, it's wise to build up your savings account so you have the funds to pay for a vehicle breakdown or home repair.
Your Plan for Financial Security Your path to financial security doesn't have to be all or nothing. One option is to add money to your savings account until you have a small nest egg (between $500 to $1,000). This should be enough to cover most unexpected expenses.
Then, you can divert your extra cash to paying down your debt. Pay off your debt with the highest interest rate first to maximize your interest savings or focus on the debt with the largest payment to add more leeway to your budget. Once your debt level is lower, you can increase your contributions to your savings account.
Open a Savings Account Today
If you haven’t already, you should open a savings account as soon as possible. Even if you only put a small amount of money into it at first, having an active savings account is the first step in building good financial habits and ensuring you have funds available in emergencies. Contact CCCU at 702-228-2228 to learn how you can open an account with us.