Should You Pay Down Your Debt or Save Your Money?

You’ve put together your budget, determining how much you owe each month, how much you owe overall, how much you earn each month and how much you have in savings. If you’re lucky, you’ve found a small pocket of money. Perhaps you’ve discovered a small amount of money each month that you could apply to your debt. Or, perhaps you discovered that you could wipe your debt out completely, as long as you wipe out your savings, too. What’s the right path to take? The answer depends largely upon the type of debt you have, as well as the type of savings you have.

Credit card debt, as a rule, should be paid off as quickly as possible. Many credit card companies stick users with high interest rates, making those loans incredibly expensive over the long term. If you have a credit card debt you’re paying 8 percent interest on and you have a savings account only gaining 2 percent interest, it makes basic sense to drain that savings account to pay off your debt. Just remember that you should immediately work to replenish that savings account. Transfer the amount you were paying to the credit card company to your savings account in your budgeting and stick to the plan. Your personal savings account should hold at least one month’s salary, so you have a cushion if something goes wrong or you face an unexpected expense.

Debt you’ve accrued in your home, or debt you owe due to student loans, should be treated with a bit of caution. Sometimes the amount of money you pay in interest on these loans can be written off during the tax season. Eliminating these payments could cost you a bit at tax time. Additionally, some of these loans are offered at very low interest rates, so the amount you’ll save by paying off these debts may not be worth the financial stress you’ll experience with nothing in savings.

When you’re making your calculations, keep your retirement accounts completely out of the picture. While you might have a significant amount of money in your retirement account, that money should be used only for your retirement. Draining these accounts to pay for your current debts is a short-sighted approach that could cause you an extreme amount of pain when you retire, and you could be on the hook for big tax penalties for withdrawing money before you retire.

If you’re simply on the fence and can’t decide what road to take, consider talking to a credit counselor and asking for advice. A credit counselor can look over your budget, as well as your accounts, and give you good advice on what you should do with your money and when you should get started.

 

Photo courtesy of jannoon028 http://www.freedigitalphotos.net/images/view_photog.php?photogid=2337

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