If you have student loan debt, credit card debt, or a balance on a personal loan, the smart thing to do is pay those debts off as quickly as possible. But as anyone who is currently dealing with debt knows, just because you that obligation to repay doesn’t mean you don’t have other financial priorities. You’ll likely want to reach other goals, too, like establishing an emergency fund or maxing out your IRA.
E.M. over at Journey to Saving recently discussed this financial conundrum, which got me thinking: what should you prioritize when you’re trying to allocate your cash to different goals and working at paying off debt? As with most things in personal finance, there is no one answer that will suit everyone’s unique situation – but we can come up with two main solutions that you can analyze to determine which one makes the most sense for you.
Paying Off Debt with the Debt Emergency Philosophy
Some people believe that having debt is an emergency in its own right, and there’s nothing wrong with letting debt repayment be your sole financial focus until all your debts are repaid. This makes a lot of sense, especially if you have a relatively manageable amount of debt – something under $10,000, for example. You could get onto a bare bones budget, limit your expenses to cover only what you truly need, and then tackle this amount of debt in 12 months or less by throwing every cent that you earn in a month at your loan or credit card balances.
I believe this is a good approach for smaller amounts of debt because it is exhausting. Having a single-minded purpose and devoting every last penny you can spare to your debt repayment is going to eat away at what you owe relatively quickly – but it’s hard to do this month after month after month with no concern for other financial goals or even a bit of “fun” spending.
This is also a good approach if the interest rate on your debt is high. The longer you hang on to your debt, the more you’ll end up owing in the long run thanks to interest. So if it’s a high rate, your emergency is to get rid of it as fast as you possibly can. It truly is your emergency.
Paying Off Debt with the Balanced Approach
If you have larger sums of debt, ignoring every other financial goal you have might not be the best strategy. You’ll be paying off that debt for a long time, even if you’re exclusively focused on repayment. You may want to devote the largest percentage of available cash to paying off debt, but you might also want to hold back a little bit to put toward something like retirement.
Your debt should still be your biggest priority, because even with a low interest rate it’s costing you money every month that you continue to carry a balance. But if you’re young, you cannot afford to not invest anything at all. Regardless of whether or not you have debt, if you have access to an employer-sponsored retirement plan you should be contributing enough to get the match. Don’t worry about adding in more while you’re working on repaying your debt – but at least grab that free money that’s being offered to you.
You might also want to consider opening a traditional IRA to take advantage of the tax benefits. What you contribute to an IRA is tax-deferred, meaning you’re taxed on the money when you withdraw it instead of being taxed in the year you put money in. This can amount to some serious savings on your tax bill in April, and that could free up funds to continue putting toward your debt.
You can also be saving for something like an emergency fund. Even if debt is your most pressing financial issue right now, there’s no telling when an unexpected expense will pop up and blow a hole through your budget – and you do not want to resort to adding to your debt in order to take care of it. You can have a set amount of money you devote to paying off debt every month, and if you have some extra money left over, don’t spend it! Add that surplus to your savings.
Or make extra savings into a game. Find easy ways to save a few bucks here and there. Maybe you can pay yourself $5 every time you do a workout (instead of buying a post-gym smoothie every time – make your own at home), and at the end of the month you transfer your “gym earnings” to a savings account you established to hold your emergency fund. Or challenge yourself to see how much you can ride your bike or take public transportation rather than using your car. Move what you didn’t spend on gas to your emergency fund.
Pick a Method that Makes Sense for You – and Stick to It
Taking a measured, balanced approach or working full-out to get rid of your debt once and for all – either way, you’re doing awesome by repaying your debt and moving toward more financial security. What’s important is that you choose an method for paying off debt that works well with your unique situation, and is something you can stick with over time until you’ve met your goals.
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