One of the questions I am asked most often is whether it’s better to pay off debt or save money first. And honestly, it wasn’t all that long ago that I was the one struggling with this dilemma.
When I was newly divorced and desperate for financial advice, I read article after article that told said things like:
- “Put all of your disposable income toward debt!”
- “Build an emergency fund to fund 3-6 months of bills!”
- “Max out your 401(k) and your Roth IRA!”
As someone who was living paycheck to paycheck, I was crushed. How the hell was I supposed to do any of those things (let alone all three of them) when I could barely pay my bills every month?
Because of the amount of anxiety I had around this question, it honestly comes as no surprise that so many people are also struggling with it.
In this post, I’m answering that age-old question we’ve all had at one point or another. Which should you do first: pay off debt or save money?
Is it better to pay off debt or save money first?
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Remember, it’s not one or the other
First things first, you don’t have to choose between just saving money or just paying off debt. You can do BOTH.
I’m not saying it’s going to be easy. In fact, I can guarantee you it’s going to be tough.
The first thing you’re going to need to do is to take stock of where you’re at. First, take some time to figure out exactly how much debt you have. It sounds obvious, but I know far too many people who just blindly make their minimum payments every month without really paying attention to how much they owe.
My favorite tool to gather all of my debt information in one place is Undebt.it. This tool allows you to add and manage all of your debt accounts, among other functions that we’ll cover later on.
The other thing you need to consider is your life situation. How much money do you have coming in? How much money do you have in savings? What are your monthly expenses? All of these factors will help you choose between prioritizing saving money or paying off debt.
Start by building your emergency fund
Regardless of whether you have debt and how much debt you have, building your emergency fund should be your very first goal. How much you actually need in your emergency fund comes down to your comfort level, among other life factors.
To figure out how much of an emergency fund you need, really think carefully about where you are in your life and what you need out of an emergency fund.
Today my husband and I both bring in income (I’m self-employed and he has a good job). Because we share expenses, I know that if I were to lose all of my freelance income tomorrow, we’d be able to get by for a while on his income.
But just a few years ago it was a very different story. Three years ago I was single, living alone, and barely making ends meet. If I had lost my job during that time, it would have immediately been an emergency.
Your life situation will tell you a lot about how much money you should have in savings. If you’ve got kids or are a one-income family, you’ll need a lot more of a cushion.
Alright, so how much should you save in your emergency fund?
Dave Ramsey recommends putting $1,000 in your emergency fund before you aggressively pay off debt. I highly recommend more than that. There are plenty of house or car repairs that cost more than $1,000 on their own. And what about job loss? For most of us, $1,000 isn’t even enough to get by for one month.
Like I said, how much you should actually save depends entirely on your lifestyle. I’m pretty risk-averse, so I would shoot for a minimum of a few thousand dollars.
Another thing to remember is that your emergency fund and your debt are totally intertwined. Nearly half of families don’t have enough to cover a $400 emergency. So when those emergencies do inevitably pop up, those families are going further into debt to pay for them.
Having an emergency fund doesn’t prevent you from paying off your debt — It helps to avoid debt!
Take advantage of an employer 401(k) match
Just like there’s a bare minimum for what you should save for your emergency fund, I also think there’s a minimum for what you should save for retirement.
Listen, I know how hard it is to care about retirement when you’re in your early twenties. I was lucky enough to get a job out of college that had mandatory pension contributions so I didn’t have the opportunity to opt out. And let me tell you, I’m so grateful that was the case.
If you start saving for retirement in your forties, it’s going to seem overwhelming. If you start saving in your twenties, it’s going to be a hell of a lot easier and more painless.
When it comes to saving for retirement, the most important factor you should look at first is whether your employer offers a match on your 401(k). If they do, take advantage of it. This is literally free money. Try to contribute as much as they’ll match.
If you can do more than that, that’s great. But if you’ve got a lot of debt to tackle, I would hit your employer match and then turn your attention to the debt.
Make a plan to pay off your debt
If you’re going to prioritize paying off your debt, you need to have a plan in place. And no, making the minimum payment on all of your debts every month doesn’t count as having a plan.
As I’ve mentioned on this blog before, my husband and I are currently in the process of paying off six figures of debt (around $150,000 to be more specific).
Had we continued to make all of our minimum payments every month, we would have been paying off that debt for literally the rest of our lives. And after putting a plan in place to pay it off faster? We’re scheduled to pay it off in about seven years.
As you can see, there’s a pretty big difference there, and it’s all because we made a plan.
To make our debt payoff plan, we used the tool Undebt.it.
The first thing you’ll do when you sign up for Undebt.it is to add all of your debt accounts. This means consumer debt, car loans, student loans, and any other debt you’re carrying.
Next, Undebt.it will prompt you to decide in what order you want to prioritize your debts. Essentially they’re asking if you want to do a debt snowball (where you prioritize the lowest debt amount) or the debt avalanche (where you prioritize the highest interest rates).
From what I read, the debt snowball seems to be a lot more popular. I understand, as paying off small debts can give you a lot of motivation. If that’s what you need, go for it.
We chose to go with the debt avalanche instead. Because of the amount of debt we have, paying off the high-interest debt first is going to save us tens of thousands of dollars in interest.
Once you’ve added all of your debts and have chosen what order you want to tackle them in, Undebt.it is going to ask you how much money you want to put toward debt every month.
This part is challenging and totally comes down to what fits within your budget. Try to find a number that is quite a bit more than just your minimum payments, but still low enough that you have money to save and money to live a little.
I know there are plenty of people who think you shouldn’t spend any fun money until you pay off debt. I 100% don’t fall into that camp. If it’s going to take me years to pay off debt, my husband and I are going to go out to eat and go see our favorite bands while we’re at it. My opinion is that you should still set aside some money for things that bring you joy.
Once you’ve got your number, you’re done! At this point, Undebt.it will tell you when you’re scheduled to pay off your debt. You’ll have to go in monthly and manually enter the payments you’ve made. As an alternative though, you can sync Undebt.it with the budget app You Need a Budget (YNAB), and it will automatically keep up to date with your balances.
Make a commitment not to go back into debt
Paying off debt is glorious. We’ve got a long way to go before we’re debt-free, but even paying off just one debt is an amazing feeling.
But paying off the debt isn’t enough.
For all of this to work, you also have to commit to yourself to never go back into debt (outside of a mortgage).
In some cases, this will be easy. Most of us aren’t planning to take on more student loan debt after we pay ours off.
But what about credit cards? Can you commit to never putting something on a credit card if you don’t already have the money to pay it off?
Can you commit to saving up to purchase cars in cash rather than taking out a loan?
After paying on my car loan for years, I was determined that we’d purchase our next car in cash. It might not be the nicest car, but it feels pretty darn good not to be making payments on it.
Once the debt is gone, go all-in on saving
When you get to this point, you’ve done the following:
- Build an emergency fund
- Put enough into your 401(k) to get your employer match
- Paid off all of your debt (YAY!)
I haven’t made it to this stage yet — we’ve got a way to go on our debt. But I can only imagine how great it feels to be debt-free. We’re probably years away, but I’m already planning what I’m going to do with that extra $2,000 per month when the debt is gone.
For many people, it’s probably tempting to spend that extra money. It’s like getting a huge raise, right?
And while I totally agree that becoming debt-free means you can start using some of that money on wants instead of needs.
But this is also the time to up your savings game in a big way.
First, this means building a hefty job-loss fund for yourself. Aim for six months of expenses in case you and/or your spouse lose your jobs.
Now that you have more disposable income, you can also start putting more into your retirement account. The younger you start saving for retirement, the more you can take advantage of that compound interest!
I know so many people stress out about whether they should be saving first or paying off debt. I struggled with this dilemma for years.
The good news is that you can do BOTH.
It is possible to save a solid emergency fund to help you out in a tough situation, while also slaying your debt.