Should I Save or Pay Off Debt? - NerdWallet (2024)

FAQs

Should I prioritize paying off debt or saving? ›

When you have high-interest consumer debt, paying it down first can help you solve ongoing problems with managing your money. The more you reduce your principal and the amount of interest you owe, the more money you'll have in your budget each month to devote to savings or other line items.

However, it's important to remember that interest rates may vary per borrower, lender and loan type. If you have high-interest debt, you may want to consider paying that down before saving. Any interest, but especially high interest, prolongs your ability to pay down your debt and wastes money you could be saving.

To pay off $6,000 in credit card debt within 36 months, you will need to pay $217 per month, assuming an APR of 18%. You would incur $1,823 in interest charges during that time, but you could avoid much of this extra cost and pay off your debt faster by using a 0% APR balance transfer credit card.

Less discretionary spending money

Whether you're paying off a loan with a lump sum or you plan to chip away at it with larger payments, paying off your loan faster will likely mean tightening up your budget.

The 50-30-20 budget rule states that you should spend up to 50% of your after-tax income on needs and obligations that you must have or must do. The remaining half should dedicate 20% to savings, leaving 30% to be spent on things you want but don't necessarily need.

Millionaires usually avoid the following: High-interest debt: Millionaires typically steer clear of high-interest consumer debt, like credit card debt, that offers no return or tax benefits. Neglect diversification: They don't put all their eggs in one basket but diversify investments to mitigate risks.

In terms of saving money, a debt avalanche is better because it saves you money in interest by targeting your highest-interest debt first. However, some people find the debt snowball method better because it can be more motivating to see a smaller debt paid off more quickly.

By paying your debt shortly after it's charged, you can help prevent your credit utilization rate from rising above the preferred 30% mark and improve your chances of increasing your credit scores. Paying early can also help you avoid late fees and additional interest charges on any balance you would otherwise carry.

If you have a credit card balance, it's typically best to pay it off in full if you can. Carrying a balance can lead to expensive interest charges and growing debt. Plus, using more than 30% of your credit line is likely to have a negative effect on your credit scores.

U.S. consumers carry $6,501 in credit card debt on average, according to Experian data, but if your balance is much higher—say, $20,000 or beyond—you may feel hopeless. Paying off a high credit card balance can be a daunting task, but it is possible.

How long will it take to pay off $20,000 in credit card debt? ›

It will take 47 months to pay off $20,000 with payments of $600 per month, assuming the average credit card APR of around 18%. The time it takes to repay a balance depends on how often you make payments, how big your payments are and what the interest rate charged by the lender is.

Prioritizing debt by interest rate.

This repayment strategy, sometimes called the avalanche method, prioritizes your debts from the highest interest rate to the lowest. First, you'll pay off your balance with the highest interest rate, followed by your next-highest interest rate and so on.

“Consumers can and should do both.” Even if you're working on paying down debt, building a healthy savings fund can help you avoid adding to that debt. Having an emergency fund reduces the financial burden when the unexpected happens, even if you start with a small amount and save slowly.

Pay the largest or highest interest rate debt as fast as possible. Pay minimums on all other debt. Then pay that extra toward the next smallest debt. Paying off a big debt can boost a feeling of control and gets rid of big interest, too.

Generally speaking, try to minimize or avoid debt that is high cost and isn't tax-deductible, such as credit cards and some auto loans. High interest rates will cost you over time. Credit cards are convenient and can be helpful as long as you pay them off every month and aren't accruing interest.

However, if you don't have that much cash to spare, then you will need to prioritize. Generally speaking, you'll get out of debt faster if you start by paying off your debt with the highest interest rate first and working your way down from there.

Paying off your credit card debt in full is almost always the optimal route when looking at the issue from a credit score and financial perspective.

Paying off your car loan early is a smart financial decision because it saves you money on interest and gets you out of debt faster.

This debt repayment method is known as the snowball method because it starts small and grows over time. The snowball method works because paying off a debt in full incentivizes you to keep working toward your goal. As you pay off your smaller debts, you'll have more money to put toward your larger debts.