Is It Better to Save Money or Pay Off Debt?

The stress of choosing between paying off debt and building savings can wreck your sleep. You’re juggling your all-day, every-day bills, trying to pay down that remaining debt, WHILE saving for your future. It’s A LOT to think about, and hard to know which thing to prioritize first.

Traditional financial advice can make it feel like this is an all-or-nothing situation. And that if you make the wrong decision, it could be devastating. That rigidity isn’t helping and certainly isn’t taking your personal financial circumstances into consideration.

What a Balanced and Empowering Approach Debt vs Savings Could Look Like for You

Fortunately, your financial life is probably a whole lot more resilient than you might think. That’s why that black-and-white thinking may have struck you as incomplete or overly simplistic.

So, before we dig into strategy, take a minute to think about what you WANT. What would your life look like if you had control over your money? What would you be able to do if you had savings you could rely on WHILE paying down your debt at a rate that is comfortable for you.

Would that look like less anxiety? More brain-space and capacity to do the things you love? Or maybe it’s just being able to sleep a little better at night.

On the financial side, maybe it looks like more trust in yourself regarding money, but also preventing new debt, reducing interest charges, and overall long-term stability.

Also read, How to Make Your Savings Stick Around a Bit

How to Find the Right Strategy for You

Step 1: Assess Your Debts

List out all of your debts, even your mortgage, if you have one. You’ll need the current balance, interest rate, and what you’re paying each month (you can include the minimum if you’d like).

Step 2: Examine Your Savings Goals

List out your savings goals. For each “allotment” of savings, try to answer the questions “What is the purpose of this savings”, and “How would I know when to use this savings?”

Step 3: Play with Scenarios

There is no one correct way to pay down debt and/or build savings. What kind of debt you have, interest rates, and balances change from situation to situation, so finding the best way to pay off your debt may require some initial experimentation.

My clients and I use this free calculator.

I recommend playing with each of these options for paying down debt:

Highest-to-Lowest Interest Rate

Pro: This strategy is likely to save the most on interest.

Con: Difficult to build momentum. If the highest interest rate debt is also the biggest, it can take years to see any progress, which may lead to falling off any payment strategy, which may inadvertently lead to more interest accrued.

Shortest-to-Longest Payoff Period

Pro: Easy to build momentum with most debts. Momentum makes it easy to feel successful in this strategy, and easier to stick with. Very often, but certainly not always, the difference you’d pay in the interest rates of the highest to lowest strategy vs the shortest to longest strategy are negligible.

Con: Depending on the composition of the debts, you may pay more in interest rates.

Lowest-to-Highest Balance

Pro: Just like shortest-to-lonest payoff, this strategy is great for building momentum, as you’ll likely see more success early and find it easier to keep going. This strategy can end up feeling like a game!

Con: Again, you might end up paying more on interest, but the difference may be small.

Highest Priority First

Higher priority debts are paid off first (sorted by emotional impact, interest rate, or balance) while all other debts only get interest paid, once the first debt is paid off, the next one is paid off, etc.

Pro: You get to decide which debts are most important.

Con: It can be frustrating just paying the minimums on the debts that aren’t the current focus, which can lead to the whole structure breaking down.

See which of these options works best for YOU and your budget.

Step 4: Make the Savings/Debt Paydown Strategy Part of a Larger Whole

It’s always best to build savings and/or pay off debt within a customized, easy-to-use, adaptable framework (i.e. budget). Paying off debt should be a strategy WITHIN the larger strategy of your budget as it increases the likelihood that your strategy will be successful.

But just trying to comply with a premade budget template will not be enough. Your goals, spending priorities and desires are unique, so custom-building a budget that thoughtfully prioritizes debt payoff is critical. Also watch out for a budget that is either too restrictive or too loosey-goosey. You need structure to carry forward your goals, but flexibility to handle emergencies, opportunities, and change in general.

Also read, How and When to Use Your Emergency Fund.

Step 5: Choose Whether You’re Going to Focus on Debt First, Savings First, or Both-And

One of my favorite concepts is treating savings goals as debts. Using the debt calculator above, run through all possible scenarios. Include your savings goals as debts in the calculator, with a 0% interest rate, and then play with how much you think you might save each month.

I’m sure you can see the recurring theme here… play, play, play. The more of these scenarios you run, the greater your comfort will be, and the more confident you will be with whatever plan you choose.

More About Savings

Carefully strategize on your savings too. Savings is the anti-debt. Over time, a carefully built savings strategy (incorporated with the kind of budget described above) can prevent future debt. I know you’re hearing advice like “just save $1,000”, or “save 6 months worth of expenses”, and that’s fine, but how do you know when to use your savings and when not to?

By carefully naming your savings allotments (and I do recommend having at least three), you know when to use it and when not to. For example, if I name my savings “emergency fund”, how the heck do I know when something rises to the level of an emergency and when it doesn’t? If I name that same savings “income drops by 20%” I not only know exactly when I should use it, but I’m also less likely to use those funds for something else and regret it later.

In Conclusion

I know this one sounds obvious, and yes you’ve heard this before, but by 1) carefully structuring how you pay off your debt, 2) building and adapting a customized budget, and 3) carefully structuring your savings, you can prevent taking on more debt in the future.

Let’s Have a Conversation:

Do you think it’s better to build your savings or pay off debt? Have you heard of any strategies to balance both? What strategy have you used/are you using?