Many Americans wonder whether they should be using their income to pay off their debts or to save the money in a bank or credit union. Most experts agree that if you are in debt and wondering what to do with your excess cash, your best bet is to begin paying off your debts first before you invest in your savings.
This is because savings accounts and other accounts that are offered by banks and financial institutions pay a minimal amount of interest. When you are in debt, especially with past-due credit card debt, chances are you are paying an extremely high-interest rate on the money you borrowed.
Just as with any situation, there are cases where it can be smart to pay off debt before saving and situations where it’s better to save than to pay off debt:
Paying Off Debt Before Saving
If you are under a large amount of debt with high interest, you could actually be saving money in the long term by paying off your debt first. Especially with large balances, interest rates can begin to take a toll.
If you have debt that is tax deductible, do not worry about losing the deduction. Chances are, the deduction that you would receive is less than the interest you would pay on the debt itself.
Saving Before Paying Debt
The main reason you would want to save before you pay off debt is to create an emergency fund (usually 8 months of living expenses saved up).
If you have low-interest debt and have very little in savings, you might need access to cash in a financial emergency. Also, if you have a retirement account through your employer, it may be beneficial to allocate money towards that instead of debts, especially if your employer matches it.
All in all, choosing between paying off debts and saving cash for the future can be a hard choice. In fact, one of the smarter answers would be to have a mix of both, which can help you get out of the debt cycle while helping you save in case of an emergency.
Peace of mind with an emergency savings fund is something many consumers value. For this group of people, taking part in paying off debt and adding funds to savings accounts may be the smart choice.
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