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Pay Off Debt or Save? What To Know

Consider your current debt and interest rates, plus the size of your emergency fund, to determine where to put your money.

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By Emily Batdorf

Written by

Emily Batdorf

Writer

Emily Batdorf is a personal finance expert, specializing in banking, lending, credit cards, and budgeting. Drawing on her scientific background, she's developed a knack for analyzing financial products in the context of different needs. She finds joy in helping readers understand their best options and shuns a one-size-fits-all approach.

Edited by Jared Hughes

Written by

Jared Hughes

Editor

Jared Hughes is a personal loan editor for Credible and Fox Money, and has been producing digital content for more than six years.

Updated April 19, 2024

Editorial disclosure: Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”

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Credible takeaways

  • You should generally have an emergency fund with at least three months’ worth of living expenses.
  • There are several ways to pay off debt, including debt consolidation and debt repayment strategies.
  • Make sure you’re not living outside your means to make the most of either debt repayment or savings strategies.

Is it better to pay off debt or save? Unfortunately, there’s no one-size-fits-all answer to this common financial question. It depends on your situation — and in many cases, the best course of action is to balance both priorities at the same time. However, there are a few rules of thumb that can help you decide when to focus on paying off debt and when to focus on saving.

Assess your financial situation

Take a step back first and assess whether you should pay off debt or save your money based on your financial situation. By doing so, you can make an informed plan to do both in a way that aligns with your priorities.

Consider the following steps:

  1. Evaluate your debt: List out all your debts, from student loans to credit card debt. Take note of each debt’s balance and annual percentage rate (APR). High-interest debt should be your main focus when it comes to debt repayment because it costs more than low-interest debt.
  2. Evaluate your savings: Take stock of any cash you have saved — and where it’s sitting. Is it earning interest? Having a sufficient emergency fund can help you cover unexpected expenses without getting into more debt. Don’t count your retirement savings during this step — instead, focus on the cash you have on hand. Those savings can pay for an emergency today
  3. Analyze your budget: Finally, know the budget you’re working with. For example, if you have $200 left after paying for all your monthly expenses, that’s $200 you have to put toward paying off debt, saving, or both. As you’re budgeting, keep in mind that any money you can free up is more money you can funnel toward savings and debt repayment.

After taking a look at your debt, savings, and budget, you can decide where to start:

  • Pay off debt: If you have high-interest debt that’s snowballing, focus on paying it down or lowering your interest rate. If you already have a sufficient emergency fund — at least 3 months’ worth of expenses saved — focus on paying down debt.
  • Save: If you have no emergency savings, then saving should be a priority. If you don’t have much debt, your extra cash may serve you better in a high-interest savings account than paying off what you do have. This way, you won’t be forced to borrow at high interest rates during an emergency.

Learn More: 

How to pay off debt fast

Unless you have a cash windfall — like from a tax refund or end-of-year bonus — or are willing to make major concessions to your quality of life, paying off debt fast may seem impossible. But there’s one way to speed up the payoff process significantly, especially if you have high-interest debt like credit card debt. You could save thousands in interest and even lower your monthly payment.

Learn More: How To Pay Off Debt Fast

Consolidate debt to a lower interest rate

If you have high-interest debt, like credit card debt, or multiple debts across different accounts, you may be able to save money with a debt consolidation loan or credit card refinance.

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The way it works is you take out a new loan (ideally at a lower interest rate) and use the proceeds to pay off your current debt. There can be a host of advantages to this, especially for credit cards, including:

  • Lower APRs: Rates on 2-year personal loans averaged 12.49% in February 2024, according to the Federal Reserve, while average credit card APRs were at 21.59%.
  • Fixed interest rate: Unlike credit card APRs, most personal loans have a fixed rate and fixed payments that won’t increase if interest rates rise.
  • Defined repayment period: Also unlike credit cards, personal loans have set repayment terms. As long as you make monthly payments on time, your debt will be paid off by the end of the loan’s term.
  • Credit boost: Consolidating debt with a personal loan can result in quick and long-term gains for your credit score. You can reduce your credit utilization if you pay off credit cards (and keep them open), and get a more affordable monthly payment, which can make it easier to make payments on time. Plus, you could improve your mix of credit (the types of debt you have). All of these can improve your score.
  • Simplified accounting: If you have multiple debts with multiple payments, tracking all of them can be a headache. A debt consolidation loan can replace multiple payments with one, which could result in fewer missed or late payments.
  • No compound interest: One of the traps to making minimum credit card payments is that any interest that goes unpaid for the month will carry over as part of your new balance to the next. Then, next billing cycle, interest will be assessed on the entire balance, including the interest charges that were carried over. This can send interest costs through the roof, and could mean decades-long repayment if you’re only paying the minimum. Personal loans do not have this feature.

Check out: Debt Consolidation Loan Rates

How (else) to pay off debt

If taking out another loan isn’t for you, consider tried-and-true alternatives.

  • Pay extra when possible: Whether you get a bonus from work, ramp up your side hustle, or receive cash for your birthday, throwing any extra money toward your debt can help you pay it off faster and save on interest.
  • Cut expenses: Scour your budget for subscriptions you aren’t using, bills you can negotiate, or any place you notice overspending. Redirect that money toward your debt to speed up repayment.
  • Apply the debt snowball method: Which debts you pay down or off first can make a difference. If you’re motivated by quick wins, pay off the account with the lowest balance, then move on to the debt with the next-lowest balance, all while making minimum payments on your remaining debt. That’s the debt snowball method.
  • Apply the debt avalanche method: If you prefer to pay off your most costly debt, no matter how large it is, focus on the debt with the highest interest rate first. Then, move on to the account with the next-highest interest rate. That’s the debt avalanche method. You should be able to save more money on interest with this method, relative to the snowball method, though it can take time to see initial wins.
  • Stay focused: Paying off debt — especially large amounts of it — isn’t easy. But the more you can celebrate your progress and stay focused on the end goal, the easier it can be.

Check out: Ways To Get Out of Debt With Bad Credit

Why pay off debt

Paying off debt may be your first priority if you have high-interest debt or a substantial emergency fund — or both. Regardless, there are a lot of ways paying off debt can improve your financial situation.

  • Saves money over time: Debt, especially high-interest debt, can make seemingly affordable purchases cost more in the long run. That’s because borrowing isn’t free — every month you carry debt tacks on more in interest payments. The quicker you pay off debt, the less it’ll cost you.
  • Improves your credit score and financial stability: Falling behind on loan payments or racking up too much debt can hurt your credit score, making it harder to borrow down the road. On the flip side, paying off debt can improve your credit score, making it easier and less expensive to borrow in the future.
  • Improve your debt-to-income ratio (DTI): If you plan to apply for a mortgage or other loan in the future, lenders will consider your DTI, or how much you pay toward debt relative to your income. Lenders prefer a DTI below 35% for personal loans, and below 43% for mortgages.

Learn More: What Is Debt-to-Income Ratio?

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Tip

Calculate your DTI by adding up your minimum monthly debt payments (including rent or mortgage payments) and dividing that number by your monthly gross income.

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How to save

Saving money isn’t always easy. But if you don't have much of an emergency fund, it should probably be a priority. These tips can help:

  • Set clear and realistic goals: Dream big, but set reasonable goals. You can always change them later. Setting goals you can reach gives you the motivation to keep going when things get tough — and provides a reason for celebration when you get there.
  • Include savings goals in your budget: Just like you budget for groceries, gas, and rent, you should budget for savings goals, too. Each month, set money aside for your various savings goals — whether that’s emergencies, vacations, or a new car. That way, the money’s there when you need it.
  • Automate your savings: If you manage your savings manually, something is bound to fall through the cracks. Make sure you save every single month by setting up automatic transfers into your savings account.
  • Keep your savings in the right places: Depending on your savings goals, you may want to keep your money in certain accounts. For example, a high-yield savings account is a great place for your emergency fund, but your 401(k) isn’t. Make sure any money you may need in the short term is in an accessible place.
  • Cut expenses: As with paying off debt, the more money you can find in your budget, the more quickly you can build your savings. See where you can cut expenses — even temporarily — and funnel the extra money toward your savings goals.
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Good to know

Your emergency fund should contain at least three to six months of living expenses — this is in case you lose your job or are unable to work. If you are a single-earner household or have a sporadic income, lean toward the higher end of that range.

Why save

If you don’t have an emergency fund — or if you only have low-interest debt — saving may be your top financial priority. If you struggle to save, understanding these benefits may help you stay motivated to stash money for a rainy day.

  • Cover emergency expenses: When you have a pool of savings to pull from, you may not need to swipe a credit card for emergencies. That means you can handle the unexpected without putting yourself in a tough financial situation or taking on high interest debt.
  • Help you reach financial goals: Whether you want to get married, buy a house, or take a vacation, savings can make these goals possible without overextending yourself.
  • Give you financial flexibility: You can buy more than a house, car, or vacation with your savings — it also affords you freedom and flexibility. For example, your savings can tide you over if you decide to switch careers or take on any other big life change.

Balancing debt repayment and saving

Balancing saving and paying off debt is possible, but you have to take stock of your finances to understand the best way to do it.

If you have high-interest debt, it’s generally a good idea to prioritize paying it off. A debt consolidation loan can consolidate your debt and help you pay it off faster. If you’re able to reduce your monthly payment, consider putting the amount saved toward an emergency fund.

And if you don’t have a healthy emergency fund, you may want to prioritize saving. But if you also have high-interest debt, you may need to take a hard look at your finances and budget. Are you spending outside of your means? If so, you’ll need to rein in your spending in order to make headway toward either savings or debt payoff.

If that’s not the case, build up your emergency fund while you pay down debt. Look for a high-interest savings account in which to save so that your savings can be earning money as well.

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Tip

Compare rates on savings vehicles and debt. For instance, if you have a mortgage at 5%, and a savings account also making 5%, you wouldn’t save any money by making extra mortgage payments (if they’d otherwise go into your savings account).

Pay off debt or save FAQ

How to pay off debt in collections

Before making any payments or acknowledging you owe the debt, check your state’s statute of limitations on debt — if the period has passed, you can use this information to protect yourself if the collector attempts to sue.

Next, determine whether you can afford to repay the debt, or negotiate a repayment plan. If you negotiate a new debt repayment plan, get the agreement in writing. Finally, report any complaints of unfair debt collection practices to the Consumer Financial Protection Bureau.

Learn More: How To Negotiate Credit Card Debt

Which debt should I pay off first?

It’s best to pay off your highest-interest debt first, as it can cost you more in the long run. For example, if you have a credit card with an interest rate of 24% and a personal loan with an APR of 10%, you should focus on paying off the credit card debt first. However, if the personal loan has a small balance and paying it off would give you a sense of accomplishment that would motivate you to pay down more debt, you may decide to start there.

How much of an emergency fund should I have?

The size of your emergency fund depends on your personal situation and risk tolerance. But in general, it’s suggested to save three to six months’ worth of essential living expenses for emergencies. Certain factors, like an unstable job or fluctuating income, may prompt you to save more. On the other hand, if you have a solid financial support system, you may be comfortable with only three months’ worth of cash.

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Meet the expert:
Emily Batdorf

Emily Batdorf is a personal finance expert, specializing in banking, lending, credit cards, and budgeting. Drawing on her scientific background, she's developed a knack for analyzing financial products in the context of different needs. She finds joy in helping readers understand their best options and shuns a one-size-fits-all approach.