The vicious debt cycle is something that almost all individuals in debt hope to escape. However, each is faced with the dilemma of deciding whether saving money is a viable option rather than paying off debt. The decision to prioritize one option over the other has remained a debated topic in the financial market’s bookkeeping realm. It is essential to be mindful of the various factors influencing whether either one is a more feasible option – optimizing savings or paying off debt obligations. These factors will be discussed in detail below:
When is Saving a Better Option?
It is usually better to emphasize saving to prepare for unforeseen circumstances. This common practice leads individuals to decide to save when they have outstanding debt in their portfolios. However, decisions vary from person to person. Situations when saving, instead of paying off debt, is a better option when any of the following is true:
- If the interest rate on a loan is low, there is no point in paying off the debt prior to saving money. Instead, the amount you will use to pay off the debt may be saved for use in the future. Lower interest rates may be a good indicator to save money now, to be used later, in accordance with the principle that dictates that saving is a better option if the interest earned is higher than the interest paid.
- Another situation when saving for an ‘emergency fund’ is a top priority is when you are close to your retirement age. At this point in time, saving up for unexpected costs and emergency expenses is appropriate to safeguard against emergencies in the future, and a consistent source of income is about to end. To ensure a stable life during retirement, saving is a better option.
- Another situation that calls for saving rather than paying off debt is when your job allows the option to access a retirement savings plan. This will automatically boost the savings made to a retirement savings account if the employer is likely to match the 401(k) contributions. This is essentially free money.
- In the case of a small amount of outstanding debt, savings may be prioritized, whereas a small amount of savings may be dedicated to paying off debt using minimum payments. This is likely to ensure that the small loan amount is paid off and ensures sufficient savings.
When is Paying Off Debt a Better Option?
Despite the need to save enough money and have cash available when needed, sometimes it is better to pay off debt rather than focus on growing savings. The following situations will require prioritizing paying off debt:
- To improve one’s credit score, paying off debt is feasible. Acquiring a higher credit score is important to be able to have sufficient credit available for use in the future. As a result of a better score, lower interest and insurance rates can be better negotiated for future loans.
- Another reason to pay off debt occurs when there is a higher than 6% interest rate on loans. With this kind of borrowing cost, it is less risky to settle the debt immediately. No one likes to end up in a situation where the interest paid exceeds the interest earned on savings. Higher interest rates are, thus, indicators that debt must be paid off immediately.
- To attract lower interest rates in the future, it is essential to lower the balances owed on any loan amounts. Making higher payments initially will result in a lower balance and, thus, a lower interest rate can consequently be obtained.
Depending on the situation and one’s personal objectives, either one of the two options may be set as a priority. Few people can successfully maintain a healthy balance between both savings and paying off small amounts of their debt. If they can, this allows them a good credit score and enough cash savings to be used in times of uncertainty. Whether you save money or settle debt, your own personal preference is based primarily on individual circumstances.
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