You can scrape together a small amount of extra cash each month, but you aren’t sure what you should do with the money. If you listen to financial expert Dave Ramsey, you will work through the Seven Baby Steps, which start with creating a $1,000 emergency fund. He also advocates debt elimination before retirement savings, reasoning that you’re less likely to borrow from your retirement funds during hard times if you eliminate debt and save first.
To determine what is right for you, there are some questions that you should answer. Under each of these questions, you’ll see a list of potential answers to use as a starting point. Add or delete items so that your final list reflects your personal situation.
What do you have to lose if you focus primarily on savings?
• You will have to continue making minimum payments on credit cards and loans, and that means wasting money on interest charges each month.
• Derogatory debt on your credit card will continue to lower your credit score.
• Even if you save a substantial down payment, your outstanding debt may prevent you from securing a home or auto loan.
What do you have to gain if you focus primarily on savings?
• You can prevent future credit card debt when you cover unexpected expenses from your savings account, avoiding interest and other fees.
• You’re less likely to worry about everyday expenses like the electric bill and food for your family, since you have savings to fall back on when necessary.
What do you have to lose if you focus primarily on debt reduction?
• You may need to borrow money if an unexpected expense comes along, you lose your job or another major financial setback occurs.
• It will make little sense to continue charging on credit cards unnecessarily, so you may have to turn down fun opportunities and make lifestyle sacrifices in order to eliminate the debt.
What do you have to gain if you focus exclusively on debt reduction?
• Your credit score will likely improve as you pay off derogatory listings and lower your credit utilization ratio.
• As you wipe out credit card and loan balances, you will stop paying the associated interest charges. Depending on the interest rates, this could mean a faster return on your money than you would get through investment in a savings account or even the stock market.
• You won’t have as many debt collectors or credit card companies calling you, and you’ll have fewer bills in the mail.
• Less debt and a higher credit score may qualify you for a home or auto loan with a low interest rate.
Is there any way to split your focus while making progress on both fronts simultaneously?
• Maybe you can save as much money as possible one month or financial quarter and then focus on eliminating debt the next, rotating your efforts accordingly.
• If you were to invest half of your money in savings and put the rest toward debt elimination, would it be enough to make any real progress on both sides? This is most likely to work if you have a substantial amount of free money each month.
• Can you participate in an employer-matched retirement fund or similar savings opportunity while also paying down debt? You may also find a way to prioritize savings while still making progress toward debt reduction.
Now that you have your answers to those five questions, are there more advantages to saving or paying off debt in your personal situation? If you decide to start saving a nest egg first, don’t make eliminating debt harder in the future. This means keeping your credit card balances as low as possible and carefully budgeting your money so that you live within your means. You will appreciate these efforts when it is time to pay off the debt.