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Should you save money or pay down debt? Which is more important? This is a dilemma many of us face especially if we have a limited income.
What Are The Pros Of Paying Off Debt First?
There are many advantages to paying off debt. Here are some of the reasons paying off debt may resonate with you.
According to the federal reserve bank of New York, total household debt was at $14.96 trillion by the end of the second quarter of 2021. In addition, Northwestern Mutual conducted a survey last year showing that 60% of Americans are worried about the amount of personal debt they are carrying.
Carrying large amounts of debt can also be stressful. Research shows debt can have a negative impact on a relationship. Paying off your debt will reduce your level of financial stress and may even better your financial stress and mental health connection.
Improves Your Credit Score and Leaves Room for More Credit
Many things determine your credit score and your capacity to borrow. For example, carrying large balances on revolving facilities like lines of credit and credit cards reduces your credit score. A poor credit score affects your ability to borrow at a competitive interest rate.
Paying off debt improves your credit score and leaves room for more credit should you need it, especially if you want to purchase an asset like a home.
What Are The Pros Of Saving Money Instead?
In June 2021, the average American saved 9.4% of their disposable personal income. However, 69% of Americans have less than $1,000 in savings.
The benefits of saving money are endless. Whether it be a leaky roof or your car breaking down, we all encounter unexpected expenses. Or it could be something worse like a sudden illness or job loss. You need to save money to build an emergency fund. You should set aside an equivalent of six months worth of income for your emergency fund in your savings account. Building an emergency fund prevents you from having to use credit to pay for the emergency. You can calculate your emergency fund amount here.
Saving allows you to do more
Having a healthy balance in your savings account allows you to do more without getting into debt, such as taking a trip to Mexico for your brother's wedding or taking time off work to attend a yoga boot camp in India.
Saving money in an account that gives you interest allows your money to grow through the effects of compounding. Compounding is earning interest on your interest. So the sooner you start saving, the greater the chances for your money to grow.
If you start investing at age 30 at an annual interest of 7%, you will need to invest just $7,234 per year to save $1,000,000 by age 65. However, if you wait until you are 45 to start investing, you will need to save more than triple that amount — $24,393 per year. That is the benefit of compound interest — and why investing early is so important.
The easiest place to start is to ask yourself how much should you save a month to reach your saving goals.
High Yield Savings Accounts
Instead of paying off low-interest loans and mortgages, you could focus on growing your savings through high yield savings accounts that earn higher interest than traditional savings accounts.
Get into the habit of saving by automatically transferring a portion of your income into a high yield savings account as soon as you get paid. You don’t even have to go to a bank to get this done.
With Monorail, you can set a savings goal and select to have a portion of your salary transferred into this account each time you get paid.
Save vs Pay Off Debt: How to Decide
If you have limited income and a lot of debt, you may feel the need to choose between one and the other. There are many variables in making this decision. The obvious is the rate of return of your savings versus the rate of interest of the debt. If you are carrying large credit card debt at 19% interest and your savings account is generating 2% interest, then it may make sense to put more of your financial resources into paying down the debt, especially if you are not able to negotiate a lower interest rate on your debt.
But the interest rate should not be the only thing that determines your decision between saving and paying off debt. You should still build savings even as you are paying off debt. This will prevent you from getting deeper into debt in the event of a financial emergency.
And if the interest rate on your outstanding debt is lower than the rate of return on your savings, then it makes sense to build your savings.
In today's low-interest-rate environment, paying off debt on appreciating assets like a mortgage on a home should not be your priority.
The Final Word On Saving vs Debt Repayment
Saving money and paying off debt are both important in a long-term financial plan. It would be unwise to focus solely on one at the expense of the other. Saving money provides you with liquidity to do whatever you want - travel, shop, or pay down debt. Whereas paying off debt will free you from financial burdens and allow you to save even more in the long run. A solid spot to begin is to increase your financial literacy to make the best decision for you and to set a money goal.
Whatever your financial goals may be, Monorail can help you save and spend in the same app – so your money is all in one place. See how saving with Monorail can help you get you where you want to go.
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