When to Save and When to Pay Down Debt

September 7, 2021

When to Save and When to Pay Down Debt

Paying down debt can be tedious and discouraging. Many people believe that paying down debt should be their first priority, even before saving or investing.

However, that may not always be the case. Depending on your particular financial situation, it may make sense to save the debt and begin investing now.

The type of debt matters

Whether it makes more sense to pay down debt or begin saving, depends on the type of debt you carry. It is important to first separate debt into three categories in order to assess your overall situation.

  1. High-interest debt – Credit cards and any loan that has an interest rate higher than 10 percent is considered high-interest debt. It is recommended to pay off this debt before anything else to avoid those high interest rates.
  2. Low-interest debt – This debt has a slightly more manageable interest rate. Generally, car loans and personal lines of credit fall under this category.
  3. Tax-deductible debt – Student loans and mortgages are considered tax-deductible debt. Many of these loans have low interest rates and qualify for tax deductions.

An emergency fund is critical

While it is recommended to pay off high-interest debt as soon as you are able, it is also important to ensure you have a good financial safety net. Before you begin paying down debt, you may want to set up an emergency fund. This fund should be large enough to cover at least three months of expenses. Consider establishing an emergency fund, before you start paying down your debt.

Don’t miss out on your 401(k)

When paying off debt, it is also important not to miss out on participating in your employer’s 401(k) plan. This is especially vital if your employer offers a matching contribution, as you don’t want to miss

out on “free” money. Be sure to contribute at a level that allows you to receive the full company match. For example, if your employer matches 50 percent on the first 6 percent of your contributions, you’ll want to defer at least 6 percent from your paycheck into your 401(k).

View your debt as a low-risk investment

Individuals who do not carry any debt generally have a diversified portfolio of high- and low-risk investments. If you have debt, you can count your low-interest, tax-deductible debt as your low-risk investments. Although you are paying an interest rate instead of earning one, you are still shrinking your debt and adding to your overall net worth.

Therefore, you may have more room to take on slightly more risk in your other investments.

Choosing to save over paying down debt is a personal decision. Your advisor can help you determine your risk tolerance, comfort level with debt and the balance that’s right for you. For more information on paying down debt versus investing,

please contact your wealth advisor.                                   



http://www.investopedia.com/articles/personal-finance/050115/mortgage-vs- student-loan-vs-saving.asp

http://money.usnews.com/money/blogs/the-smarter-mutual-fund- investor/2013/04/02/whats-your-risk-tolerance

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