Two of the most important attributes of a financially stable individual are a healthy savings account and no more debt than is manageable for that person’s budget. But which is more important? Is it better to have a large savings or get out of debt sooner?
The answer will be unique to your situation. We’ll help you understand how to resolve this question for yourself and your specific goals.
What it means to prioritize debt vs. savings
To prioritize paying down debt over building up more savings simply means to channel what money is left after paying your essential expenses toward outstanding balances instead of your rainy day fund. This can help you to quickly eliminate expensive interest charges—which can feel like the equivalent of lighting your cash on fire. Yes, taking on debt is often necessary in many life situations, but any time you can avoid incurring interest, you should.
To prioritize savings over debt means to continue making the minimum monthly payments on your current loans and put any remaining income aside for an emergency. This gives you some breathing room in case you experience a major curveball such as a job loss. It’s wise to have six months’ worth of savings accessible in a high-yield savings account emergency fund to help you weather such circumstances.
Pros and cons of paying off debt before saving
Pros
- Reduce amount paid toward interest faster
- Improve your credit by lowering utilization
- Lower your overall debt-to-income ratio
Cons
- No cushion (or less cushion at least) for emergencies
- Potentially pass on valuable tax-advantaged savings programs
- Inability to take advantage of valuable opportunities without sinking further into debt
Pros and cons of saving before paying off debt
Pros
- Freedom to move quickly when a good opportunity shows up
- Funds to help you get through crises like job loss or medical emergencies
- Learn to live well below your means
Cons
- Pay more in interest charges over the long run
- Debt-to-income ratio remains mostly the same
- May be tempting to use your savings for nonessentials
How to decide whether to save or pay off debt first
You’ve got a finite amount of money. Do you throw it towards reducing your current debts or fortifying your savings account? Here are some questions to ask yourself to help you find the solution.
What type of debt do you have?
Not all debts come with equal payoff urgency. For example, high-APR credit card balances are a far greater waste of money than, say, a mortgage with a much lower interest rate.
That said, unsecured loans (like most credit cards) are somewhat less important than secured loans (like auto loans, mortgages, and some personal loans), as failure to repay a secured loan can result in losing assets like your house, car, jewelry, or other collateral you’ve used to borrow money.
If you’ve got a secured personal loan, you’ll typically need to prioritize your ability to repay that above all else. You’ll have to decide for yourself whether that means funneling as much money as possible toward the loan now or putting money toward savings to ensure that you can continue to make payments during a possible hardship.
What are your interest rates versus potential returns?
Decide where your money does the most good. Would you gain the biggest effective return by putting your savings in the bank or paying extra on your current debts?
As an example, you may have a $20,000 auto loan with a 3.90% APR over five years. You may also have a high-yield savings account currently offering 4.21% APY. To decide which is the better choice, do the math to see which will ultimately put more money in your pocket:
- $20,000 at 3.90% APR over 5 years amounts to $2,045.71 in total interest. Putting an extra $200 per month toward your bill will reduce your interest paid to $1,276.01—saving you $769.70.
- Putting that $200 into a high-yield savings account with 4.21% APY over 5 years will result in $1,349.65 of earned interest (though your take-home will be lower after taxes).
In this scenario, it would likely benefit you mathematically to save instead of putting extra money toward your auto loan. This also gives you the benefit of creating a solid buffer to protect you from unexpected emergencies.
Just keep in mind that the best high-yield savings accounts don’t have fixed APYs; the yields they offer can change overnight, so if you can’t reliably find a new savings account with a similar return, it may make sense to simply put more money toward your loan.
How secure is your income and emergency fund?
If you already have substantial savings that can get you through an extended period of hardship, there may be no need to prioritize a savings account over debt. Focusing your money towards eliminating loans (and therefore minimum payments) can improve your monthly cash flow. On the other hand, if you have no emergency fund just yet, building one up while paying the minimum on your debts may be prudent.
What are your short- and long-term goals?
Short-term aspirations such as moving, changing jobs, starting a family, etc. typically prioritize putting your money into savings.
Longer-term goals may favor paying down debt as quickly as possible. You may need to lower your DTI to buy a home—and you’ll be able to afford a larger monthly payment if you’re not beholden to multiple other minimum payments such as credit cards, personal loans, etc. Or if you’re trying to retire early, reducing your debts will help you to require less money to live on.
Ways to pay off debt while still saving
You don’t necessarily have to choose paying off debt or saving exclusively; it may be possible to do both. For example:
- You can pledge a modest dollar amount each month to your savings account (you can often automate these transfers). Then put everything else toward lowering your outstanding balances.
- As you pay off an account, you’ll reclaim a portion of your monthly income that’s gone toward its minimum payment. You can split that money between savings and paying your remaining balances.
- Any time you receive a lump sum of money, such as a bonus or a tax refund, you can direct those toward your savings and debt repayment—instead of using it recreationally.
The takeaway
Paying off debt and saving money are both exceptionally important for a healthy financial profile. If you don’t have the funds available to meaningfully do both, you’ll need to decide which is more important for your situation.
Consider the types of debt you have, the interest rates to which you’re subject, your short- and long-term goals, and your current savings account balance. Having a clear-eyed understanding of your budget is key, and we recommend prioritizing at least a small emergency fund so that unanticipated circumstances don’t set you back in a catastrophic way.
Frequently asked questions
Is it better to pay off credit card debt or build an emergency fund first?
It’s better to build an emergency fund first before you pay off credit card debt. This will let you navigate a period of hardship without any accounts falling into delinquency—a dagger in the heart of your credit score.
How much should I save before focusing on paying off debt?
Experts recommend saving until you can afford between three and six months of essential expenses. The specific number this amounts to will depend on what your household needs to cover housing, food, etc. each month.
When should I prioritize paying off debt over saving?
You should generally prioritize paying off debt over saving if you’ve already built a decent emergency fund and you’re dealing with high-interest balances—such as credit cards. However, if you’ve only got low-APR loans like a mortgage or auto loan, it could be worth putting extra money into a high-yield savings account if you can reliably find APY that outweighs the savings you’ll experience by tossing extra payments toward those accounts.
How do I decide between paying off debt or saving if my income is unstable?
If your income is unstable, you should absolutely save as much money as you can. Having cash on hand is more important than having lower debt balances.
How does my debt-to-income ratio affect whether I should pay off debt or save first?
A high DTI (50% or more) tends to make paying down your current balances more urgent, as it’s a major signal that you’re carrying too much debt. A high DTI can also dramatically affect whether you qualify for future loans.
