Why Paying Down Debt Is the New Savings Strategy
Common financial advice urges prioritizing saving, building emergency funds and investing for the future.
But in today’s high-interest-rate, high-cost environment, many financial experts say there’s another move that can sometimes improve your finances even faster: aggressively paying down debt.
Here’s what that could look like.
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Why High-Interest Debt Can Cost More Than Saving Helps
While high-yield savings accounts may offer returns around 4% to 5%, many credit cards now charge interest rates over 22%. Thus, debt payoff has a “guaranteed 22% return,” according to Russell Moran, owner of debtcalcpro.com.
Not to mention, if you don’t get on top of credit card debt, interest can stack up so far it’s hard to get ahead of it.
Sean Fox, president of debt resolution at Achieve, laid out a scenario of a person with $3,000 in credit card debt at a 20% interest rate, with only minimum payments of interest plus 3% of the balance.
“[It] would take more than 15 years to pay off and end up costing more than $3,300 in interest alone,” he said.
How Paying Off Debt Improves Cash Flow Faster
Another reason debt payoff has become so appealing is that it can immediately free up monthly income.
“Every debt you eliminate … you can put that toward something else,” Moran said. For example, eliminating a $300 monthly car payment means you can put more money in savings.
Fox also noted that lower debt balances can improve credit scores because “amount owed” makes up 30% of FICO scores. Lower utilization may eventually reduce borrowing costs on future loans and even lower insurance premiums.
The Emotional Benefits of Reducing Debt
Debt payoff can have other benefits beyond the financial.
“It’s a well-known fact that debt is a major cause of stress,” Fox said. “Conversely, not carrying debt lessens stress.”
Ashley F. Morgan, debt and bankruptcy lawyer at Ashley F. Morgan Law, PC, added that many consumers unfairly blame themselves for debt struggles. Repayment can help shift the mindset from away from debt as “a moral failure,” back to being merely “a financial issue,” she said.
Morgan also warned against unrealistic online budgeting advice "to eliminate every small enjoyment from their lives, stop retirement contributions entirely, never eat out, never travel and work nonstop until all debt is gone." She said that approach is not realistic or emotionally sustainable for many households.
Why Paying Off Debt Shouldn’t Mean Ignoring Savings
Even experts who strongly support debt payoff caution against draining all savings to eliminate balances.
“If you have no emergency fund, you are one bad day away from disaster,” Moran said.
Fox advised consumers to prioritize necessities first while still building at least a small emergency reserve.
“Starting with even a few hundred dollars saved up can reap big benefits in preventing additional credit card debt,” he said.
And while debt payoff is important, overly aggressive debt payoff plans can backfire if life circumstances change unexpectedly.
“If your debt payoff plan depends on nothing going wrong for the next five years, it is probably not a realistic plan,” Morgan said.
Which Debt Repayment Strategy Works Best?
Fortunately, there are multiple kinds of debt repayment plans to accommodate different lifestyles and budgets. Moran strongly favors the snowball method for motivation.
“It gives you the sense of ‘I have accomplished something’ so you can move on," he said.
Morgan feels the avalanche method saves the most mathematically, but she made clear that “the best method is usually the one the person will actually stick with consistently.”
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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