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Finances & Money

Pay Down Debt or Increase Savings?

Ok, you got some extra cash each month. You also have some student loans, auto loans, personal loans, credit cards, or any combination. You want to increase your emergency fund, but you also want to pay down that debt (without piling up more). Which do you do?

1) Split your extra cash: half to debt, half to savings

2) Pay all to the debt

3) Put all of it in savings

There’s a few more choices in between all those, but for this discussion, let’s use polarizing options. What are the pros and cons of each? And how do you ultimately decide?

Truthfully, alot of the decision is emotional. Do you want to feel like you’re accomplishing something, or do you want to do what is logical? What is your risk tolerance? If you ran into financial problems, can you borrow money from family or friends? Do you have extra room on your cards? Can you take out a short-term loan?

I can’t decide your best option without knowing your specific condition, but here’s a couple of pointers using the options above:

1) If you have a lot extra each month ($1000+), then think about splitting it between savings and debt, unless you have debt with a really high interest rate (10% or higher). Splitting the amount will lessen the appearance of making headway on either front, but at least you’re doing something. However, if you have a high interest loan, then get out of it as quickly as possible.

2) If you don’t have much to spare each month (less than $1000), then look into whether you can make more interest in savings than what you’re paying on your debt. Most likely, you’re paying more interest on debt that you’re making, so put that extra cash towards the debt. However, if you don’t have much room to wiggle on your credit lines, then you may want to think about putting more into the kitty for that rainy day that ends up flooding your house.

My example: I have alot of room on my credit cards in case of emergency (job loss, incapacitation, etc.) and at a low interest rate. Additionally, I can take out a home equity line of credit if I absolutely must (I’d rather not though). My highest interest rate on debt is about 6.5%. I can make about 5% on my liquid savings. Therefore, I’ll put a majority of my extra income towards my debt because I can handle the risk.

If you have any helpful hints, shoot me a comment. Experience is the best (and usually the hardest) way to learn.

About the author

Clever Dude

2 Comments

  • Since our only debt is a mortgage at around 6%, we have to consider if it’s better to put more into savings at 5.35% (minus taxes) or into paying off the mortgage at about 6% (minus tax deduction). I did the math one day and figured out that math is hard, so I just spend all the money on candy instead.

  • […] to the personal finance gurus) praising the benefits and indeed necessity¬†of an emergency / rainy day […]

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