Pay Off Debt or Save? What You Should Do and Why

Whether you should pay off debt or save money depends on your financial goals, the type of debt, interest rates and your emergency savings. For instance, if you're carrying high-interest debt, you'll want to pay off those balances quickly — otherwise, they can snowball. Conversely, if you have $0 in savings, you should prioritize building at least a small emergency fund. Ultimately, you want to comfortably address both goals.

"Paying down debt while saving money is a great way for any consumer to build healthy financial habits and create a positive financial profile," said Leslie H. Tayne, founder of Tayne Law Group, a debt resolution firm.

Of course, financial multi-tasking is often easier said than done. Learn when and how to prioritize paying off debt vs. savings.

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Pros and Cons of Paying Off Debt First

Pros

• Saves money on interest

• Frees up future monthly income

• Improves credit score over time

Cons

• Leaves less money for emergencies

• Can delay investing or retirement goals

• May not help if you keep taking on more debt

Pros and Cons of Saving First

Pros

• Creates an emergency cushion

• Builds good savings habits

• Gives you peace of mind

Cons

• Debt interest may grow faster than savings

• Can delay financial freedom

• Harder to focus on two goals at once

When To Focus on Paying Off Debt

• You have high-interest debt, like payday loans, which can carry an annual percentage rate (APR) of almost 400%, or credit cards, which have an average APR of 21% and compound interest. "These debts can grow, and clearing them first frees up money for other goals, like saving and investing," said Ronnie Allan, head of consumer credit card and personal lending at PNC Bank.

• You have other pressing debts, like collection accounts or loan delinquencies. In this scenario, consider seeking outside assistance or exploring more extreme solutions to get out of debt, such as consolidation, credit counseling or debt settlement.

• You're paying more interest than you'd earn from savings. That's not to say you should skip savings altogether, as you want enough cash to cover emergencies. It suggests you should divert more disposable income to satisfying outstanding debts, as you're losing more than you're gaining in interest.

• Your debt is keeping you from a mortgage or other financial goals. Most lenders look for a debt-to-income ratio of 36% or lower. Consider prioritizing payoffs if your outstanding balances currently exceed that level, particularly if you're looking for approval on a new loan.

When To Prioritize Saving Money

• You don't have an emergency fund. "This savings account will protect your financial well-being as [it] gives you a cushion to pay for unexpected bills and emergency expenses," said consumer finance expert Andrea Woroch. "Without this savings, you'd find yourself borrowing money or using a credit card to get through a tough financial time."

• Your debt has a low interest rate, which is more common among mortgages, personal loans and federal student loans. Given the low borrowing costs, these balances are generally easier to manage and less of a threat to your financial health.

• You have a specific short-term savings goal in mind, such as money for a vacation, a wedding, or a big move. Avoid taking on extra debt to finance these scenarios, however.

• Your employer offers a 401(k) match. This benefit is essentially extra income and a means to lower your annual taxable income, as the money you save in these accounts is tax-deferred.

Pay Off Debt or Save? A Side-by-Side Comparison

Reference the chart below to assess which healthy habit — paying off debt or saving money — will best serve your current financial goals or situation.

How To Decide: A Simple Step-by-Step Plan

Struggling with where to put your disposable income? Take these steps to determine the best use of those funds.

1. Check Your Interest Rates

"Look at what you're paying in interest on your various debts to figure out where you're wasting the most money," said Woroch.

Consider whether your debt works for or against you also. Some balances can help you build wealth.

A mortgage, for instance, allows you to pay over time for an appreciating asset — your home. This debt type, along with low-interest loans, can often take a back seat to saving or investing goals.

2. Build an Emergency Fund

Experts recommend having at least three to six months' worth of emergency savings. That way, you can cover critical bills, like rent or utilities, if your employment status changes or unexpected expenses arise, such as a car or home repairs.

"Keep in mind, though, that as you build that emergency fund, you should still be making minimum payments on all debts," said Allan. "Missing those can hurt your credit score."

3. Tackle High-Interest Debt First

Use the debt avalanche method to save time and money. This do-it-yourself (DIY) repayment strategy involves making minimum payments on all outstanding debts, while allocating extra funds toward your highest-interest balance, and then repeating this process until you're out of debt.

Other strategies for getting out of debt on a low income include finding new revenue streams, negotiating with creditors, or exploring alternative debt relief solutions, like debt settlement or debt management plans (DMPs).

4. Increase Savings

As your debt gets less expensive — or even better, nonexistent — you can divert more disposable income to your savings goals.

"It's best to aim to save 20% of your monthly income, ideally in a high-yield savings account, but any percentage a consumer saves is better than none," Tayne said.

5. Reassess Your Plan Every Few Months

Financial situations and goals change, so pulse-check your priorities regularly. For instance, if a car repair drained your emergency fund, you might need to divert more money to savings. Conversely, if you unexpectedly carry a credit balance from one month to the next, you might need to free up funds to minimize interest payments.

"Always try to save at the same time you're working to pay off debt," Woroch said. "However, don't let interest fees pile up."

FAQs

Can you pay off debt and save at the same time?

If you can afford it, you should absolutely pay off debt and save as both are important financial goals. Sometimes, one goal may take precedence over the other. For instance, you might consider only making minimum debt payments if you have no money in an emergency savings account. Alternatively, you might pause savings if you have a high-interest debt that threatens to spiral out of control.

How much emergency savings should I have first?

You should have at least three months' worth of emergency savings before accelerating debt payments, as that's the minimum amount experts generally recommend keeping on hand for a rainy day.

What if I'm behind on both saving and debt?

Consider seeking professional help. Non-profit credit counseling agencies often offer free consultations and can help you explore more extreme debt relief solutions, like debt management plans or bankruptcy.

Should I invest instead of saving or paying off debt?

It's usually best to pay off debt instead of invest when the interest on outstanding balances is high. For reference, the average annual stock market return is around 7%, when adjusting for inflation. Investment accounts often have higher yields than traditional savings accounts, but they're not always guaranteed, and you'll sacrifice liquidity, or cash flow. Ultimately, the best move varies depending on your financial profile and risk tolerance.

Can I refinance or consolidate debt to save money?

Refinancing and debt consolidation are among the go-to strategies for people carrying high-interest debts, and will save you money if you qualify for lower APRs.

• The pros of debt consolidation include: potentially lower APRs, a set payoff date and fewer monthly payments.

• The cons include origination or balance transfer fees and long-term debt risks.