by Maja Majewski

Should I save money or pay off debt first?

Deciding whether to pay off debt or save money first can feel like a real ‘chicken and egg’ kind of situation. Is there a way to do both? Yes. Here’s how!
Saving vs Debt

If you’re living with the burden of debt, you can probably think of several financial and emotional reasons why you’d want to pay that off as quickly as you can.

One of the most frustrating parts of having financial debt is that it limits your ability to put your money toward your future. You know that the faster you can pay it off and become debt free, the sooner you can start working toward other financial goals, like saving for retirement, travel, or growing a family.

But you also have other financial obligations and goals that you want to be saving money toward, like building up an Emergency Fund and contributing to a retirement plan.

If you’re barely able to pay your bills and make your minimum monthly payments, the idea of saving money might feel impossible. But we’re here to help you figure out how to save money and stay focused on paying off your debt at the same time. (You got this, we promise!) Here’s what you need to know about how to prioritize your various personal finance priorities.

Know what you owe.

When you’re trying to decide whether to save money or pay off debt first, it’s important to know what kind of debt you have. While personal finance experts debate whether there is such a thing as ‘good debt’, there are certainly some debts that are less ‘bad’ than others.

What makes some debt better than others?

There are several practical reasons that you might’ve taken on some debt at one point or another, to invest in yourself or build equity. For example, you might be one of millions of Americans who chose to take out student loans in order to pay for a secondary education.

Investing in your education can help you make more money over the course of your lifetime - but many Americans are finding that they aren’t able to pay off their student loan debt as quickly as they would’ve hoped.

The good news is that although student loans can be substantial, they typically carry lower interest rates than other forms of debt (usually between 3-7%, compared to 19%+ for credit cards). Your goal for these types of lower-interest debts should be to pay them down consistently, and as quickly as possible without going into further debt.

No matter what kind of debt you carry, it’s important to have some money saved up to help you avoid going into further debt. Here’s why.

How saving money can keep you out of further debt.

Whether you have $500 or $50,000 of debt to pay down, you probably have these two goals:

  1. Pay off the debt as quickly as possible
  2. Avoid going even further into debt

This can feel like a ‘chicken and the egg’ type of situation - in order to pay off the debt as quickly as possible, you want to be able to put all of your money towards it. But if you don’t have some money saved, you risk going even further into debt if you can’t cover your monthly bills.

For example, what if you suddenly have to go to the dentist and are left with a $300 bill? If you don’t have any money set aside, you risk going further into debt.

What you want to have is an account buffer - a cushion to cover the small ebbs and flows of monthly expenses, without having to touch your savings or use money that could be going toward your debt repayment.

Like a mini Emergency Fund, an account buffer can simply be a few weeks of living expenses that you use to cover smaller, unplanned expenses. If you don’t currently have an account buffer, try to build one up ASAP - start with two weeks of living expenses as a goal.

If possible, start automating saving a little bit from each paycheck to put into your account buffer. This will not only help you if you get into a bind, it’ll also help you get into the habit of saving. Once you have your two weeks set aside, continue saving into a separate account, called an Emergency Fund. You can learn all about Emergency Funds here!

Prioritize your high-interest debt payments.

Paying off high interest debt.

Let’s talk about the other kinds of debt, the kind that you should try to pay off as quickly as possible. High-interest debt can be financially crippling, because the longer it takes you to pay it off, the more you’ll have to pay over time (like, a lot more).

Unlike student loans and mortgages, which typically have interest rates lower than 5%, credit card debt usually carries interest rates of 19% or higher. The most common type of high-interest debt is credit card debt, of which the average American household carries over $6,829.

Prioritize paying off high interest debt first…

If you currently have a balance on one or more credit cards, figure out which cards are charging the highest interest rates. Once your account buffer is funded, create a plan for paying off your highest interest debts first.

Here’s how:

  1. Figure out how much money you can devote to paying off debt each month.
  2. Figure out how much you’re paying in interest on your card(s).
  3. Figure out the minimum monthly payment due on your card(s).
  4. Call the credit card companies and ask for a lower interest rate for each card.

…while still paying your minimum payments on other debts.

Even though you want to pay off your highest-interest debts ASAP, you also will want to avoid paying late fees - that’s why it’s important to pay at least the minimum due on every card, to avoid additional fees.

So while it’s true that you want to pay off your highest-interest debts ASAP, it’s more accurate to say that you want to pay off your highest-interest debts ASAP while continuing to pay the minimum monthly payments on your remaining debts.

So, to figure out your debt repayment plan:

  1. Take the total number you have available for debt repayment each month.
  2. Subtract the minimum monthly payments you’ll pay for each of your debts.
  3. Put the rest toward your highest-interest debt.

Once that one is paid off, tackle the next one, etc. until all your balances hit zero.

Don’t miss out on compounding interest.

Although retirement may feel forever away, you shouldn’t delay saving for retirement if you can avoid it. That’s because of a little thing called compounding interest. Unlike the bad kind of interest that you pay on your credit card or student loan debt, this is the good kind of interest, one that helps you earn more money over time.

Earn interest on your Emergency Fund.

You might not feel able to set aside for long-term savings or retirement right now - and that’s okay (you’ll get there!). But that doesn’t mean you can’t be earning some compounding interest on your emergency savings in the meantime. One way to earn interest on your savings, even as you’re paying off debt, is to earn interest on your Emergency Fund!

We might be a little biased, but we’d recommend starting an Emergency Fund in a Simple Protected Goals Account! That way it can earn interest - like 30x more than the national average.* Whether you have $50 or $5,000 in your Emergency Fund, you’ll be earning a little more on it every month.

If you can, set up automatic payments to fund your Emergency Fund whenever you get paid. It’s okay if it’s just $10 or $20 a month for now. (Whenever you do have more money available though, start contributing more!)

Start saving for other financial goals (so you don’t sabotage your savings progress).

Finally, if you want to pay off your debts ASAP and avoid future debt, try to stay ahead of upcoming expenses so that you can save up cash for them. For example, are you going to be in a friend’s wedding this year? Do you like to treat your loved ones around the holidays? Is your pet getting older and starting to develop some more-expensive health conditions?

If you know these things are on the horizon, try saving for these types of financial goals in a different savings account than your Emergency Fund. (In your Simple Account, you can create Goals for each of them so that you can save up for them automatically over time. Learn more about that here.)

This will help you avoid dipping into your Emergency Fund or debt repayment money to cover these larger-than-usual costs.

Imagine yourself debt-free.

Imagine if instead of funneling those monthly payments toward your balance each month, you were depositing them into your savings account!

You’ll get there one day. But in the meantime, it is important to have some cash set aside for unexpected expenses that could hit you at any point. And when you do achieve that debt-free status, start saving at least some of the money you had been putting toward payments toward long-term savings!

*Based on the November 18, 2019 National Average Rate.

Start an Emergency Fund

Disclaimer: Hey! Welcome to our disclaimer. Here’s what you need to know to safely consume this blog post: Any outbound links in this post will take you away from, to external sites in the wilds of the internet; neither Simple nor our partner bank, BBVA Compass, endorse any linked-to websites; and we didn’t pay/barter with/bribe anyone to appear in this post. And as much as we wish we could control the cost of things, any prices in this article are just estimates. Actual prices are up to retailers, manufacturers, and other people who’ve been granted magical powers over digits and dollar signs.

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