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Paying Off Debt vs Saving Money

Is It Better to Pay Off Debt or Save Money?
Lauren Ward
Lauren WardUpdated February 25, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Is it better to save or pay off debt? Paying off debt vs. saving often comes down to three variables: how much high-interest debt you have, whether or not you have emergency savings, as well as what stage of life you're at. Many borrowers may find the best results come from a healthy balance of the two, while others may need to make one or the other a priority.Find out what variables you need to consider when choosing whether saving or paying off debt is the best option for you, along with the pros and cons of each. 

Is It Better to Save or Pay Off Debt?

Save or pay off debt? The answer is — it depends.If you don’t currently have at least three months’ worth of living expenses set aside in a savings account that you can tap for the unexpected — such as an expensive car repair, unforeseen medical bill, or a job loss — then you’ll want to make saving a priority, while continuing to pay the minimum on your debts. Why? Without a cushion of savings, you’re at risk of going further into debt should an unusually large expense come up.Another scenario in which it can make sense to put saving over debt repayment is if you have access to a 401(k) at work and your employer offers matching funds. If you’re not contributing at least up the match, you are essentially throwing away free money. So, even if you have debt, you may want to increase how much you are contributing to your 401(k) savings — at least up to the matching fund threshold — while continuing to pay the minimum on your debts.What if your employer doesn't offer matching funds? If you are just starting out in your career, it’s still important to contribute at least a small percentage of your paycheck to a retirement fund. Saving enough to retire one day generally requires the power of compound interest (when the interest you earn also earns interest) over a long period of time. If you start too late, it can be difficult to save enough.Last but not least, if your debt is relatively low interest, you may want to make savings a higher priority than debt repayment. The reason is that you could likely get a higher return on your money by investing it than paying down your debt.

Types of Debt

There are all different kinds of debt and it’s generally okay to carry some debt. After all, borrowing money is often the only way people can afford expensive items like a home or a college education. Debts with very high interest — often referred to as toxic debt — are a much bigger concern than debts with low rates and favorable terms. Some of the most common debts consumers have include: 
  • Student loans
  • Auto loans
  • Personal loans
  • Credit card debt
  • Mortgages
  • Medical debt
  • Lines of credit
  • Payday loans
  • Bank overdrafts
Recommended: How Do Banks Make Money and Generate a Profit?

How Much to Save Before Paying Down Debt

Generally, you’ll want to have a decent emergency fund before you focus on paying down debt. Ideally, your emergency fund should be able to cover three to six months’ worth of living expenses. (If you're self-employed or work seasonally, you may want to shoot for 12 months.) This cushion will allow you to cover an unexpected cost or event (like a trip to the ER or a job loss) without relying on high-interest debt. Often, the cause of debt trouble is a lack of emergency savings. Building an emergency fund can help break the debt cycle. Where to start?Make a list of all of your monthly fixed expenses, as well as your day-to-day expenses, including:
  • Rent/mortgage
  • Utilities
  • Groceries
  • Transportation
  • Steaming services
  • Gym membership
  • Car payments
  • Other debt payments
  • Insurance
Once you have a sense of how much it costs you (on average) to live each month, you can calculate your emergency fund target. You may want to include only essential expenses, assuming you would cut back on discretionary spending should you lose your income or have to cover an emergency expense, or include all spending.As you build your emergency fund, be sure to keep making the minimum payments on your debts to avoid late fees or penalties. Once you have at least three months’ worth of living expenses set aside, you may want to make debt repayment your priority, while continuing to add at least some money to savings each month.Recommended: How Much Do People Keep in Savings vs Checking?

Paying Off Debt Before Saving

If you already have an emergency cushion (that could cover at least three months’ worth of living expenses) and you have high-interest debt like credit card debt, you may want to prioritize paying off debt over saving. For example, if you can potentially earn a 6% annual return in a retirement account and you’re paying an 18% annual percentage rate (APR) on credit card debt, it makes economic sense to focus on wiping out that debt before putting money into savings.By paying off debt, you’ll also be able to eventually boost your savings — any money that was going toward interest payments can now go right into your savings account. And, as long as you already have some emergency savings, you won’t be at risk of running up more debt should an appliance go on the fritz or your car breaks down.Recommended: How Much Does the Average American Have in Savings?   

Having a Debt Repayment Plan

There are a variety of ways to approach debt repayment. Two popular methods are the snowball method and the avalanche method. With the snowball method, you list all of your debts in order of amount, starting with the smallest balance and going to the highest. You then focus on putting extra payments on the debt with the smallest balance, paying just the minimum on the others. When that debt is paid off, you go to the next highest balance. This gives you a psychological boost because you’re able to cross debts off the list quickly, giving you motivation to keep at it.With the avalanche method, you list your debts in order of interest rate, with the highest interest debt at the top working down to the lowest interest debt. You then focus on putting extra payments on the highest interest debt, while paying the minimum on the rest. When the top debt is paid off, you funnel your extra payments on the next debt with the next highest interest, and so on. This approach saves you more money than the snowball method, since you’re wiping away the most expensive debts first.Whichever way you go, an easy way to level up your efforts is to put any windfalls (like a bonus at work, a cash gift, or a tax return) right into debt repayment. 

Having Savings Goals

Building your emergency savings and retirement fund are important savings goals. However, you likely have others — such as buying a car or a home or saving for a child’s future college education. Whatever your goals, here are some things to consider as you work toward achieving them.

Common Places to Keep Your Savings

If you don’t have one already, you’ll want to open a savings account to keep your short-term savings separate from your spending and earn a higher return on your extra cash. While traditional savings accounts typically pay low annual percentage yields (APYs), you can usually earn significantly more with a high-yield savings account at an online bank. 

Setting Savings Targets

A good first savings goal is to fully fund your emergency fund. If you already have three months’ worth of living expenses saved, consider increasing that to six or nine months’ worth of expenses.  Experts generally advise putting 10% to 15% of your paycheck into a retirement fund, such as a 401(k) or individual retirement account (IRA). If you’re just starting out, you may need to start lower and gradually build by 1% or 2% per year.Other savings goals might include:
  • Making a downpayment on a home
  • Buying a car
  • Paying for a wedding
  • Going on vacation
  • Buying furniture
  • Buying electronics
  • Paying for a child’s education
For savings goals that you want to accomplish in the next few months or years, consider putting the money in a savings account that earns a competitive annual percentage yield (APY), such as a high-yield savings account, money market account, or certificate of deposit (CD).For nonretirement savings goals that are at least five years off, you may want to consider opening an investment account at a brokerage house. While investing involves risk, it also has the potential to yield higher returns than you can get in a savings account.Recommended: How to Save Money to Move Out

Budgeting Your Money

It can be difficult to meet any savings goal without setting up a budget. While budgeting may sound restrictive, it’s simply a way to make sure your spending lines up with your priorities. In the end, it can actually help you to do more with your money, rather than less.  One common budgeting framework is the 50/30/20 budget. With this method, 50% of your take-home income goes to needs, 30% goes to wants, and 20% goes to debt repayment (beyond the minimum) and savings. But these percentages are far from set in stone. If you have high levels of debt, you’ll likely want to reduce the wants category and increase your debt payments.Recommended: 8 Popular Budgeting Apps for Couples 

Pros and Cons of Paying Off Debt vs Saving

Pay off debt vs saving can come down to the pros and cons of each. 
ProsCons
Paying Off DebtSave money in interest If you don’t have any emergency savings, you could end up running up more debt
May strengthen your credit score and profile You miss an opportunity to grow your money and invest for the future
Frees up monthly cashSome financial institutions charge fees for early pay off
Building SavingsHaving savings can prevent you from running up more debtInterest on credit cards may outweigh interest gained on savings
Can earn interest on your moneyThe longer it takes you to pay off debt, the more you will pay in interest
The earlier you start saving for retirement, generally the less you’ll have to put awaySaving may be slow because of minimum monthly debt payments
Recommended: What is Zero-Based Budgeting?

The Takeaway

There’s no one simple answer to the question, is it better to save or pay off debt? Generally speaking, if your debt is expensive and you already have at least three months’ worth of living expenses socked away in a savings account, you’ll want to focus on debt repayment. If, on the other hand, you don't have any emergency savings or your debt is relatively low interest, you may want to prioritize saving over debt repayment. Also, if your employer offers matching 401(k) funds, consider funding at least up to match, since you don't want to leave any free money on the table.If you’re looking to get the best rate on your savings, Lantern by SoFi can help. With our online banking marketplace, it’s fast and easy to compare high-yield savings accounts based on APY, fees, and balance minimums. Lantern can help you compare online savings accounts and find today’s best rate.

Frequently Asked Questions

Is it better to pay off debt or keep money in savings?
Is paying off debt considered saving?
How much money is good to save before paying off debt?
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About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
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