Today’s post is contributed by Amy Nickson, a passionate writer on finance. Amy is a professional blogger whom has started her own blog and also works as a contributor for the Oak View Law Group. Please share your opinions by commenting below.
We all have those financial insights like “You should live within your means”, “You need to save as much as possible”, and “Debt is forbidden”, etc. But in reality, there are so many expenses that we can’t ignore – groceries, utilities, child’s education, etc.
In addition to this, unwanted stuff happens every day – your car battery dies, your son breaks a leg, your roof needs a maintenance, and you realize that you have no savings and a pile of existing debts you have to take care of.
Thus, sometimes we feel overwhelmed about “Should I focus on paying off the financial obligations first or save for future?”
Yeah, making personal financial choices can be overwhelming, because, there is no universal answer that fits all.
However, you should pick the right one as per your financial situation and circumstances.
When it is wise to pay off debt before saving
Having higher interest consumer debt can be dangerous; it is wise to pay them off first.
If you are paying more on debt than you are earning, then you’re actually losing money.
By paying the higher interest debt, you can solve the ongoing money issues in your life as well. Moreover, you can get a guaranteed return by cutting down the interest payments.
Some financial experts say that by cutting down interest payments, a debtor can earn more than what he/she could earn in the stock market and in the savings account.
Kevin Smith, executive vice president of wealth management for Smith, Mayer & Liddle has said, “It generally makes sense to emphasize debt reduction. Building a sizable reserve in a savings account might offer comfort, but it comes at a low return and a high cost”.
However, some people think, by paying off the debts like mortgage and student loan, they can lose the tax deductible interest.
But, as per the financial experts, people don’t have to worry about losing a tax deduction because the deduction is worth less than the annual interest they would have paid on their debt.
Thus, paying down the debt before saving makes sense. Once you pay off your debts, you can concentrate on the other financial goals like – money saving.
How can you pay off your painful debts?
If you have multiple debts, then you have to target the most expensive debt to pay it off first. If you only make the minimum payments, then you are racking up the huge interest day by day. By doing so, you are actually making the debt more expensive. Therefore, it is important to pay more than the minimum to get rid of the painful credit card debts.
Most of the Americans are dealing with a pile of high-interest credit card balances. Thus, they should work on them first. Then comes the private student loan debt, which is again an expensive debt most of the students are dealing with. Lastly, you should continue making the monthly payments toward your govt. student loan and mortgage.
It is easy to rack up huge credit card debts but tough to pay them off. To become debt free, you need to identify your expendable income first. Based on that income, you need to formulate a budget where you have to include the debt payments as one of the significant parts of the expenses.
You can also try to convince your creditors saying that you are trying your best to repay the outstanding balance. The creditors may agree to lower the interest rates or erase a part of the credit balance.
If you are still not able to manage your credit card debts, then you have to pick a debt repayment plan as per your financial ability.
These days, some DIY debt repayment plans like debt snowball method and debt avalanche method are becoming popular among debtors.
However, if you want to save on the interest, you have to choose the debt avalanche method since this method targets the highest interest rate debt first.
However, professional debt relief options like debt consolidation, debt settlement or, debt management, can effectively help you to get rid of debts.
After paying off the painful debts, make sure you manage your bills efficiently to avoid debt in the future.
When it is wise to save money before paying off debt
There is nothing more beneficial than having fat savings. If you don’t set aside enough money, you are actually digging the debt hole.
Yes, as I said at the beginning of the article that if an unexpected expense hits, you will have no other choice but accumulating debts to combat with. Thus, you should prioritize in building an emergency fund.
Melissa Joy, CFP professional, partner and director of wealth management at the Center for Financial Planning in Southfield, Michigan has said, “If you don’t have any savings, focusing solely on paying the debt can backfire when unexpected needs or costs come up. You might need to borrow again, and debt can become a revolving door”.
How can you build good saving?
As per the financial experts, your emergency fund should have enough money so that you can depend on it for 3 to 6 months.
Thus, you will be able to fight back with emergencies like job loss, car breakdown, an accident, and natural calamity.
Once you stash a fund of 3 to 6 months’ worth of expenses in a savings account, you can earn a decent interest from the saving as well.
After building an emergency fund, you should work on the retirement saving to secure your financial future.
Because, without having enough money, it is not possible for you to maintain your current lifestyle in your retirement.
Remember, in the future, the cost of living will rise. Thus, if you want to adjust with the future inflation, you have to be financially prepared.
So, contribute enough money to the 401(k) account. You should start contributing to a retirement fund as soon as you start earning.
The businessinsider.com suggest that “If your employer matches 50% of your contribution up to 4%, then you should make an 8% contribution. That will give you a combined 12% annual contribution, and the 4% being kicked in by your employer will represent free money”.
Lastly, financial priorities are the matter of individual circumstances and choices.
If you are young and have started earning a good amount, then it is wise to pay off the entire burden of student loan debt. After that, you can concentrate on the savings goal.
Remember, the most important thing is to manage your finances well.
If you use your credit cards randomly and don’t repay them back, you will never be able to achieve other financial goals like – building an emergency fund, saving for retirement, investment, buying a house, etc.
Taking out a loan will be the only option that you have to consider to fulfill every wish. And, most likely, your whole life will pass by making the debt payments.