Budgeting is already a tough job. You need to consider what expenses should be dealt with first. Weighing your options, setting up a budget, and sticking to it can be pretty frustrating.
Should you pay debts or save?
Choosing between saving and paying off debt is not a clear “black and white” situation. This is especially true for young professionals who just started earning money while paying his or her student loans.
Should you pay the student loan, or should you build your emergency savings first? What is the best option for your situation?
The ideal setup
The majority of financial analysts will tell you to pay off your debt while building your emergency savings.
This way, you’re chipping away your financial responsibilities little by little without sacrificing your ability to save for emergencies.
Unfortunately, this is only doable if you have a good source of regular income and a low amount of debt.
Take Note: not everyone has the same situation. A person might have a good monthly income but has tons of high-interest debts.
Meanwhile, someone might be earning lower monthly income, but are paying long-term, low-interest debts.
When to prioritize saving?
Here are some considerations that might help you analyze your situation and make good decisions.
If you don’t have any savings at all
An emergency savings account can give you a bit of time and resources until you figure out your next move. Paying your debt is only helpful if you have an established emergency fund that can support your basic needs for a few months.
What help would you get from diligently paying your debt when you might not have an excellent place to sleep the following month after?
After paying out your necessities, save your leftover money into a savings account. Even if you only save little by little each month, these small funds will create a pool of savings that can help you get out of your financial problem.
Answer: Start a small savings
Your employer offers 401(k) match
If your employer efforts a perfect 401(k) match program, you must take advantage of this opportunity.
People usually ignore their retirement funds, especially those who are just starting in the workforce. Why fund your retirement if you’re still young, and your retirement years are still decades away, right?
However, it would be a missed opportunity if you don’t contribute when your employer offers a maximum match. It’s like turning away free money that can earn more money for you.
Not to mention how you will likely miss the effect of compounding interest, which can give you more earning capability if you start early.
Answer: Max out your 401(k) and pay your debts down
If you don’t have job security
Job security has been shaky for many people in the past year due to the effects of the COVID-19 pandemic.
Those who have not deposited a dime on their savings account had it even worse than those with savings. The financial damage will even be more significant if you’re living from paycheck to paycheck.
Think of It This Way: if you try to pay your debts first, there is no telling what will happen next if you lose your job.
Answer: Start a small savings
Debt with low-interest rates
Debts can get out of control pretty quickly. That is one reason why most people try to get rid of their financial obligations as soon as possible.
After all, paying for high-interest rates can be a pain in the neck. However, if you have a low-interest rate debt, you might want to consider bolstering your savings first.
Low-interest rate debts like mortgages and student loans can be a bit more forgiving. Its interest expense doesn’t skyrocket in the same way as high-interest financial obligations.
Holding these debts for a little bit to make your emergency savings account is worth the time sacrifice. Having a source of money when you need it is a better option.
Answer: Build sizeable savings and then pay your debt
The ideal emergency savings amount
Ideally, you should aim for a savings amount that can support your necessities for at least three months.
If you can, aim for the optimal six months. The bigger your emergency savings is, the longer it can support you during challenging times.
- Add all your essential expenses (groceries, utilities, rent)
- multiply the sum by the number of months that you want your fund to last (minimum of at least three months, ideally six months and up.)
- Only add recurring expenses, and avoid those which are considered as “wants.”
When to prioritize debt payments?
Here are the times you must prioritize debt.
If you’re paying a high-interest debt
Debts with high interest (payday loans, car title, and pawnshop loans) should be paid off as soon as possible. The high rate of interest expense can cripple your finances.
Another debt that needs quite a bit of consideration is credit card debt. This type of debt is notorious for causing people to overspend, resulting in a bill that has a high-interest rate. The longer this debt is left unpaid, the worse things can get.
Answer: Pay off all your debt!
When your monthly income is certain
If you have a regular source of income, paying debt becomes more manageable. You can set up a budget with set payments that won’t affect your quality of life.
Once these debts are paid, you can finally start to save for your emergency fund. If the regular income is quite substantial, you can be able to save while paying for debt as well.
Answer: Pay off all your debt, but also plan a savings plan.
Image credit: [KAROLINA GRABOWSKA]