I think that the most common email I get from readers is “Should I pay off my debt or start investing and/or saving?”…and while there is no sure fire, no doubt about it answer, there are some general rules that you can follow. I am by no means a financial advisor, but there are a few things for you to consider.
1. If your only debt is student loan payments, there is generally nothing wrong with paying them down as laid out in your agreement with the lender and saving money at the same time. More often than not the interest rate on the student loans is lower than your saving rate, so you should do both at the same time. If you are saving in a retirement account, this makes even more sense because you don’t pay any taxes on this money until you withdraw it and it lowers your taxable income each year.
2. If you have credit card debt that has higher interest than the percentage you get back on a savings account, by all means pay off the credit card debt. Think about it…if you owe $5,000 on a credit card at 9% and have $5,000 in a savings account earning 5%, you are effectively giving up 4% worth of interest for nothing. You are not “saving” anything, but rather you are losing money each month. It may feel like you have money because your bank account says you do, but you actually don’t. Take the $5,000 out of your savings and pay off the card, which even though it will feel like you don’t have any money at all will give you an instant return of 9% on your money. This will enable you to actually earn interest on any savings you still have, and by not having any payments due to the credit card you can invest that money every month. In no time you will have your balance back up to where it was before and you won’t be losing money every month.
Once you have paid off your high interest debt, imagine not only the mental freedom but the financial freedom as well! This frees up money you can invest each and every month, and you get to keep all that money you make. (Minus taxes, of course) But keeping your money in a savings account while carrying debt with a higher interest rate makes no sense at all. Sure, it might feel like it does because you have “money”…but I put money in quotes because you don’t really have anything at all; you owe it to the credit card company.
Anyway, I know this is pretty basic stuff, but since I keep getting emails asking about it, I figured I would put together a quick little post about it. If you still have questions, please feel free to ask and I will do what I can to help you out!