Should you pay debt
Simple math suggests it’s better to get rid of debt before saving for retirement or adding to your emergency fund.
“In general, if you have high interest-rate debt that is not tax deductible, you should pay it off before saving,” says Laurie Itkin, a financial adviser and wealth manager at Coastwise Capital Group in La Jolla, California. “You don’t earn much, if any, interest on your savings, yet you have to pay interest on your debt. If the interest you pay is higher than the interest you earn, you are losing money.”
But personal finance decisions rarely are so simple, and ditching debt first isn’t the right choice for everybody. For example, it can mean not having an emergency fund to fall back on, setting you up to take on more debt any time an unexpected expense hits.
Here, we offer scenarios for when each choice – saving or paying down debt – makes the most sense.
When your liabilities include things like credit card debt or that loan you got from the furniture store to buy your couch, paying debt first can help you solve ongoing problems with managing your money.
“Not only is consumer debt high interest, but in my experience with clients, 99% of the time, consumer debt is created when lifestyle exceeds resources,” says Lauren Klein, CFP® professional, the founder and president of Klein Financial Advisors in Newport Beach, California.
Identify your real expendable income, create a budget based on that number and include paying down debt as a significant part of the equation, Klein says.
Paying debt first also makes sense because you’re getting a guaranteed “return” by cutting your interest payments. It’s typically more than you’ll earn in the stock market and definitely more than you’ll earn in a savings account.