Balancing Debt Repayment and Savings
Here’s the scenario: You’d like to start saving toward a home, but you’ve got a new baby and you’ve racked up a lot of credit card debt. Or maybe your kids are nearing college age and you know tuition will cost a lot, but you still have some outstanding debts hanging over your head. How can you decide between saving for important goals and paying down debt balances? It’s all a matter of balance. Here are some rules of thumb.
Focus on Overdue or High-Interest Debts
If you’ve fallen behind on payments, it’s best to dedicate any cash you to catching up so you can avoid additional interest, penalties or other consequences, like a lower credit score. The same is true if you’re regularly making only the minimum monthly payment on loans or if you have high-interest loans or credit card balances. In both cases, your total interest costs will be lower if you pay down your debt sooner, pay off a high-interest rate loan or transfer the balance to a lower-rate loan.
Be Prepared for Emergencies
If you don’t have any kind of rainy day fund to cover unexpected expenses, then it’s probably wise to start an emergency fund, even if you still have existing debt that’s not overdue or subject to a high interest rate. The goal should be to put aside enough money to cover at least three to six months’ worth of your expenses. If that sounds like a lot, remember that the most important step is simply to start saving. Even if it’s just a little each week, stick with it and don’t dip into this account for non-emergency spending. You’ll find that you have what you need before you know it, especially if you set up regular transfers from your checking to your savings account.
Focus on Retirement
It’s never too soon to start saving for retirement, and it should always be a top agenda item. That’s particularly true if you’re eligible for an employer’s retirement savings plan that will match your contributions. The match is a free bonus that will help ensure a more secure retirement later. And the longer you save, the more time your money has to grow. If you’re keeping up with debt payments and lowering outstanding balances, then it makes sense to add retirement savings to your budget.
Compare the Payoff
When you’re considering paying down debt versus savings, you may wonder if it’s better to save because of the interest or earnings your money can build. You may find, however, that whatever your savings can earn is less than the interest you will pay. For example, if you believe you can earn 7% each year on an investment, that doesn’t offset the 18% interest charge on a high-interest credit card. This simple comparison can make it easy to see which choice is best for you.
Turn to Help
Still not sure what’s the best move for your financial plan? Your local CPA can help provide guidance and reassurance to get you on the path to success.