You may not realize it, but by paying down your debt, you ARE saving! Actively reducing debt means you’re saving on interest, avoiding late fees, and maintaining or increasing your credit score. For today’s blog we’ll focus on why paying down debt should be acknowledged, utilized, and celebrated as a form of savings and an important component of your financial plan.
How Does Reducing Debt Help You Save?
Consumers often think saving and reducing debt are two unrelated goals or that saving money is more important than lowering debt. However, that is not always the case. By ignoring your debt, you could put yourself in a financially damaging position. This is mostly due to high-interest rates and your regular payments leaving nothing extra aside to pay down what you owe (the principal balance). This keeps your debt high and prolongs your payments to the creditor.
Equifax (and other credit-reporting companies) suggest paying down any high-balance and/or high-interest rate debt while contributing minimally to a high-interest rate savings account. Consider saving with your Credit Union’s high-interest Rainy Day Savings account. Alternatively, keep additional funds on deposit in our High Yield Checking account, which pays 4% on qualifying balances up to $5,000.
Reducing debt can take a vicious circle and turn it into a virtuous one. By first reducing debt, you could go from spending your spare cash on making interest payments, to freeing up more cash to use on savings because you are now spending less on interest payments.
What To Prioritize And When
If you have high-interest-rate consumer debt, you would likely benefit from paying down the debt rather than savings. By doing so, you may significantly increase your financial return, more so than you would investing in the stock market or using a savings account. However, there may be situations when saving should come before reducing your debt, such as having a 401(k) matching program with your company, lower-interest rate debt, or student loans that can be deferred interest-free for an extended period of time.
How To Cut Debt
If you have decided to reduce your debt to maximize your savings down the line, the best way to determine how much to pay towards your debt is by creating a budget. To do this, we suggest using an easy online application like your Credit Union’s best-in-class interactive Budgeting Tool.
It makes light work of budgeting and you’ll be able to see how much extra income you have at the end of each month. Your regular minimum debt payment should be counted in your expenses so that the extra money is genuinely “extra.” Then decide how much extra money you feel comfortable using to pay down your debt, balanced with how much less you are comfortable saving each month.
If you already have an emergency fund, you can probably pay more to reduce debt and save less. However, if you are still working on growing an emergency fund, you may want to put more towards savings until you have a small emergency fund. If you have multiple debt accounts, pick one to focus on first. Some people may choose to focus on the account with the highest interest rate, or they may choose to focus on the smallest balance to eliminate one payment faster. It’s up to you to decide what proportion of debt repayment versus savings makes the most sense for your situation.
If you still aren’t sure what option makes the most sense for you, consult someone who can help. A free financial advisor, a tax accountant, or a private financial expert are all excellent choices. There are also free calculators and tools online that can help you figure out how long it will take you to pay off your debt, as well as how much you can save over time. You should never feel like you have to guess how to use your money best.
By seeking extra help, you can drastically improve your financial situation. For candid advice that is always intended to help only one person – you – feel free to contact your Credit Branch Counselor, or call 800.877.2345. You can also set up a free Financial Wellness Check designed to help you find easy ways to earn and save more.