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This is a huge conversation in the personal finance world and one that really has to be personal when it comes down to it. If you’re a Dave Ramsey follower, then you know what the answer would be. But, if you’re someone that has made your own path navigating your finances, then it can take a bit more thought.
I personally come from a view of creating long term goals and then short term goals to reach those goals. I know for me, following the baby steps just won’t get me to my long term goals. Not as fast as I’d hope anyway.
My end goal is to reach FIRE, not necessarily to retire, but to have the freedom to do whatever work I want, regardless of pay. Right now I’m stuck at my job solely because of my debt and grants I received from my undergrad and grad studies.
These are the steps I followed in order to create a plan for myself in regards to paying off debt or saving.
1. Create long term goals.
Think about big picture, where do you want to be in 20 years? When do you see yourself retiring? Where do you see yourself working? Do you have any goals you want to reach that are impacted by your financial status?
Once you know your goals and have them written out, it will make it so much easier to figure out your financial plan based on those goals. Everyone has different goals, so everyone’s financial plan should look different. This is why I don’t really agree with the baby steps. Yes, his steps work, but only if you have that specific goal in life and you’re life aligns with the steps.
For me, I had $200k in student loan debt and I’m in my 20s. You’re crazy if you think I’m putting off saving and retirement for as long as it’s going to take to pay off my debt. This is why it is so important to think about your specific goals and what helps you to reach those goals.
2. Create short term goals.
Once you have your long term goals mapped out, create short term goals to reach your long term goals. For example, my long term goal is to reach FIRE. My short term goal I am working on is to pay off my private student loans and then my high interest Federal student loans. Once that is done, I will be increasing my savings and retirement contributions, while I pay off my lower interest student loans.
You have to think about what you need to do to reach your long term goals. Depending on what your goals are, everyone’s short term goals will look different. Take the time to really think about what makes the most sense for your long term goals and don’t be afraid to change them as you get closer to reaching your long term goals. For example, originally I wanted to pay off all of my debt, but then I realized that some of my debt has such a low interest rate that it would do better in a retirement account.
You just need to make sure that your short term goals are realistic to reaching your long term goals. As you move through the process, make adjustments as necessary. Life changes and things happen that we can’t expect. It’s important to make adjustments in the ever changing seasons of life.
3. Adjust your budget to reflect your goals.
Once you have your goals written out, you need to update your budget to reflect your goals. No matter where you are in your journey, you need a budget to reach your goals. Without a budget, you won’t know where your money is going or where to send it. What I mean by this is, even if you have no debt, if you don’t tell you money where to go for investment or savings goals, it will just sit in your account. If it’s just sitting in your checking account it isn’t working for you when it could be.
Create your budget to align with your goals, I would suggest zero based budgeting to make sure you are accounting for every penny. I have Google sheet templates available to purchase, if you need help with this!
Personal finance is personal and you ultimately need to decide what is best for you.
There is a one size fits all answer for this. I am definitely not saying debt is good, but depending on the interest rate and your long term goals, it may be mathematically smarter to contribute more to investing and less to debt. You need to take the time to really think about what your goals are and what you want for your life. Once you have that figured, you can create a plan that gets you there.
FAQs
Prioritizing debt repayment before saving is a prudent financial strategy that can lay the groundwork for long-term financial stability. This approach acknowledges the urgency of addressing existing debts, particularly high-interest ones, as they can be a substantial drain on your financial resources.
What is the best way to prioritize debt? ›
Prioritizing debt by balance size.
This strategy, also called the snowball method, prioritizes your debt payments from smallest to largest. You'll continue to pay the minimum on all of your debts while focusing the majority of your repayment efforts on your debt with the smallest balance.
How much money should you save before paying off debt? ›
With no emergency savings to draw on during a crisis, you may have to rely on a high-interest credit card or a personal loan to cover the costs. To avoid compounding your debt, try to set aside between three- and six months' worth of expenses in an emergency fund in a high-interest savings account.
Is it better to pay off debt or have a bigger down payment? ›
If you're not focusing on paying down debt faster, you may pay for it in interest charges on your outstanding balances. It won't help your credit. Although a larger down payment can make it easier to qualify for a lower interest rate, it won't help much if your credit scores are being dragged down by high debt.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
Should I pull from savings to pay off debt? ›
It's best to avoid tapping into your emergency savings to pay off debt, as you could wind up accumulating more debt when an emergency arises. Part of your decision-making about emergency savings should include how much access you have to your money, according to Shipp.
Which debt should be paid off first? ›
Delinquent accounts.
If you have any debt that's highly overdue, it's best to start with that account. Delinquent accounts can have a substantial impact on your credit, just like accounts in collections, so those should be your first priority when paying off debt.
What are the 5 golden rules for managing debt? ›
Master your money with 5 golden rules of personal finance
- It's a simple rule, but it's still the most potent piece of money wisdom: don't spend more than you earn. ...
- Rule 2 – Create an emergency fund.
- Rule 3 – Pay down debt as a priority. ...
- Rule 4 – Create money goals. ...
- Rule 5 – Make your money work for you. ...
- Recommended reading.
When to pay debt first. If your debts have high interest rates that can snowball if not paid off. If your debt is causing you significant stress or anxiety. If a large portion of your income is going toward monthly debt payments and limiting financial flexibility.
What are the three biggest strategies for paying down debt? ›
Decide which debt-repayment method is best for you — the snowball method, the avalanche method, or debt consolidation. Establish a budget to determine how much money you'll allocate to repaying debt each month. A debt repayment calculator can help you plan your payments.
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.
Do millionaires pay off debt or invest? ›
Millionaires typically balance both paying off debt and investing, but with a strategic approach. Their decision often depends on the interest rate of the debt versus the expected return on investments.
How to save money and pay off debt at the same time? ›
7 tips on how to pay off debt and save at the same time.
- Create a budget. ...
- Prioritize your debts. ...
- Make more than the minimum payment on your debts. ...
- Consider debt consolidation. ...
- Set savings goals. ...
- Automate your savings. ...
- Cut back on unnecessary expenses.
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. Consider where you'll get the money to pay off your debt — is it being diverted from your retirement savings plan?
Am I better off saving or paying off my mortgage? ›
In principle, if you're offered a higher interest rate on a savings account than the rate you pay on your mortgage, it could mean it's best for you to save. However, if you're paying a higher interest rate on your mortgage than you could earn from a savings account, it might be best to pay off your mortgage first.
Is it better to pay old debt or let it fall off? ›
Defaulted debt can crush your credit score and hurt your chances of borrowing money in the future, whether it's applying for a mortgage, car loan or credit card. If you have the means to pay off old debt, it will help your overall credit — both your score and your report.
Should you pay debt or save for emergency first? ›
First things first: Build an emergency savings fund
Before you start deciding whether to pay down debt or build up your savings, you need to protect yourself with emergency savings. An emergency savings fund could help you avoid going into debt if you have to deal with unexpected expenses.
Is it better to pay off debt at once or over time? ›
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.
Is it worth paying off debt early? ›
Interest savings: You'll save money on interest costs that otherwise would have gone to your lender. Lower debt-to-income ratio: Lowering your DTI ratio may result in a higher credit score and more favorable loan terms in the future. Freedom from debt: You'll enjoy the emotional and mental benefits of being debt-free.
