Should You Pay Off Debt or Save First?

Many people wonder what to do when they have debt but also want to save money. Should you pay off the money you owe, or should you save money first? This can feel like a tricky choice. Both paying off debt and saving are important for your finances. The good news is you can do both – it’s all about finding the right balance. In this guide, we’ll explain in simple terms how to decide what to do first, step by step.

Start with a Small Emergency Fund

Life is full of surprises. Cars break down, people get sick, or you might lose your job. This is why you need an emergency fund – some savings for unexpected events. It’s a good idea to start by saving a small amount, like $1,000, before you focus on paying down debt. Even a small emergency fund is a safety net. It means if your tire blows out or you have an urgent bill, you can use your savings instead of a credit card. Having this cushion will keep you from going deeper into debt when surprises happen.

Why $1,000? For many beginners, $1,000 is a reachable goal that can cover basic emergencies (like a car repair or a medical bill). It gives you breathing room. If you save up this starter fund first, you won’t panic or turn to high-interest debt when life throws you a curveball. Remember, this is just a start. You can save more later, but $1,000 is a common rule of thumb for a starter emergency fund.

Don’t Miss Out on Free Money (401(k) Match)

If you have a job with a retirement plan like a 401(k), find out if your employer offers a matching contribution. A 401(k) is a special savings plan for retirement, and some employers will add money to it whenever you do (this is called a "match"). For example, your company might match dollar-for-dollar up to 5% of your pay. That means if you put in 5% of your paycheck, they also put in 5%. This is free money for you!

Even while paying off debt, it’s wise to contribute enough to your 401(k) to get the full employer match. Not doing so is like leaving money on the table. You’re basically getting an instant return on your investment. So, before making extra debt payments, make sure you’re grabbing this free money for your future. It’s okay to save for retirement a little even as you pay down debts – especially when your employer is giving you a boost.

Pay Off High-Interest Debt (Credit Cards) First

After you have a small emergency fund and you’re getting any 401(k) match, the next priority is tackling high-interest debt. The best example of high-interest debt is credit card debt. Credit cards usually charge a lot of interest (often 15% or more each year). Interest is the extra money you pay to the lender for borrowing money. High interest makes debt grow fast, which costs you more money over time. It’s like a hole that gets deeper every month if you only pay the minimum.

Focus on paying off credit card balances as fast as possible. Why? Because no savings account or investment will likely grow as fast as a credit card will cost you in interest. For instance, if you have $1,000 on a credit card at a 18% interest rate, that could cost you up to $180 in interest in a year. In contrast, putting $1,000 in a basic savings account might earn you around $10 to $30 in a year. Paying off the card saves you a lot more money than that savings would earn.

Start by always paying at least the minimum on all your debts to avoid fees and credit score damage. Then throw any extra money at your credit card debt. As you pay down the balance, the interest you owe each month will also drop. This is like getting a guaranteed return on your money because every dollar of debt you pay off is a dollar you no longer pay interest on. Prioritizing credit card debt is one of the best moves you can make for your financial health.

Tip: If you have more than one credit card debt, you can use the debt snowball or debt avalanche method:

• Snowball: Pay extra on the smallest balance first (while paying minimums on others). When that’s paid off, move to the next smallest. This can give you quick wins.

• Avalanche: Pay extra on the highest interest rate debt first (while paying minimums on others). When that’s paid off, tackle the next highest interest debt. This saves more money on interest in the long run.

Choose the method that keeps you motivated, but either way, keep chipping away at those high-interest balances. Once your credit cards are paid off, try to pay the full balance every month going forward so you never fall back into high-interest debt.

Student Loans: Pay Them Off or Save?

Student loans usually have a lower interest rate than credit cards. Many federal student loans, for example, might have interest rates in the single digits (often around 4–6% annually). This is still money you owe, but it’s not as costly as credit card debt in terms of interest. So, should you pay off student loans quickly or save money instead? The answer can depend on your situation and comfort level.

Here are a few things to consider with student loans:

• Always pay the minimum on time to avoid penalties and keep your loans in good standing.

• If your student loan interest rate is moderate (say around 5%), you might choose to do a mix of both saving and paying extra. For example, you could continue to build your emergency fund or contribute to retirement while also paying a bit extra toward the student loan principal when you can.

• If your student loans have a very low interest rate (or are temporarily 0% interest), it might make sense to prioritize other goals (like saving or investing) while just paying the minimum on the loan. Your money could grow more elsewhere.

• On the other hand, some people just prefer to become debt-free faster for peace of mind. There’s nothing wrong with paying extra on student loans if being out of debt makes you feel secure, even if the interest rate isn’t very high.

In simple terms, student loans are usually not as urgent to pay off as credit cards, but they shouldn’t be ignored either. After tackling credit card debt, keep building your savings and consider putting some extra money toward student loans if it makes you more comfortable. Just balance it with your saving goals. If the interest is high (for example, some private student loans can be 8% or more), then you’d want to pay those off more aggressively because 8% is pretty high. If the interest is low, you have more flexibility.

Mortgages: Long-Term, Low-Interest Debt

A mortgage is a loan for buying a house. Mortgage loans usually have a low interest rate compared to credit cards and even many student loans. For many people, mortgage rates can be around 3–6% (though rates can change over time). A mortgage is also a long-term debt (often 15 or 30 years). Deciding whether to pay off a mortgage early or invest/save instead is a common question.

Generally, a mortgage is considered "good debt" or at least okay to keep for a while, because:

• It’s tied to an asset (your house) that can maintain or increase its value over time.

• Interest rates are relatively low, and sometimes mortgage interest is tax-deductible (depending on your situation and local tax laws, which a tax advisor can explain).

• If you have extra money, you might earn more by investing or putting it in retirement savings than you’d save by paying off a low-interest mortgage early.

This means, in most cases, paying off your mortgage early is not the first priority. Of course, you must keep making your regular mortgage payments every month. But if you come into some extra cash, it often makes more sense to use it for other goals (like beefing up your emergency fund, saving for retirement, or paying off higher-interest debt) before you consider throwing a lot of money at paying off the house early.

Some people do dream of being completely debt-free, including no mortgage. That’s a fine goal if you’ve covered your other bases. But for a beginner, it’s usually wiser to focus on things like emergency savings, high-interest debt, and retirement contributions first. Your mortgage can be paid off over time as planned. You won’t want to neglect building wealth and security (through savings and investments) just to pay off a low-interest loan faster.

Bottom line for mortgages: Pay them on schedule, but it’s okay to save and invest for your future rather than making extra mortgage payments, at least until you’re in a very strong financial position with no other debt and a fully funded emergency fund.

Finding the Right Balance

So, should you pay off debt or save first? The answer is a little bit of both. Think of it less as "either/or" and more as a priority list:

1. Safety first: Make sure you have a small emergency fund (so you don’t go back into debt when something unexpected happens) and always pay your minimum debt payments on time.

2. Grab the free money: If you have a 401(k) match or similar benefit, contribute enough to get that match, even while tackling debts. This is a smart exception to the "debt first" idea because it’s a guaranteed return on your savings.

3. Attack high-interest debt: Focus most of your extra money on paying off high-interest debts like credit cards. This frees you from heavy interest costs.

4. Build more savings: Once the bad high-interest debt is gone, grow your emergency fund bigger. Aim for 3–6 months of expenses in savings to protect you from bigger emergencies (like job loss or major repairs). You can save this up gradually.

5. Pay off other debts vs. invest: For medium or low-interest debts (student loans, car loans, mortgages), decide based on interest rates and your comfort. If the interest is moderate, you can split your money — some to extra debt payments, some to savings/investments. If the interest is very low, it’s okay to just pay the minimum and put more into savings or investing for the future.

6. Keep good habits: Continue saving for retirement and other goals as you pay off debts. Once debts are paid, you can put those freed-up dollars into more savings, investments, or other important goals (like buying a home, if you haven’t, or your kids’ education, etc.).

Everyone’s situation is a bit different. If your job isn’t stable, you might want a bigger emergency fund sooner. If you have very high-interest debt, you might throw every extra penny at that debt for a while (after the $1,000 cushion and 401k match). The key is to stay balanced and adjust as needed. The path above is a general guideline that works for many people.

Remember, personal finance is personal. Some people feel anxious with any debt and choose to pay it off faster; others feel better having more cash in the bank. It’s okay to adjust the plan for what helps you sleep at night, as long as you’re making progress. Just don’t skip the important steps (having at least some savings, not missing out on employer match, and tackling high-interest debt). By covering those bases, you’ll be in good shape.

Helpful Rules of Thumb

To sum it all up, here are a few simple rules of thumb that beginners often follow:

• Save $1,000 for emergencies before paying down debt. This starter emergency fund will handle small surprises and keep you from using credit cards for emergencies.

• Contribute to your 401(k) up to the full employer match before making extra debt payments. If your company offers to match your contributions, take it – it’s free money for your future.

• Pay off high-interest debt (like credit cards) first. High-interest debts cost you the most, so tackle them as soon as possible once you have a small emergency fund in place.

• Always pay at least the minimum on all debts. This avoids late fees and keeps your credit score healthy while you work on your plan.

• Prioritize low-interest debt last. Debts like many student loans or mortgages can be paid on schedule while you focus on building savings and investing. Once you’ve handled the priorities above, you can decide if you want to pay these off early or not.

By following these guidelines, you won’t have to choose between saving and paying off debt – you’ll be doing both in a smart way. You’ll build a cushion for the unexpected and steadily get rid of the debt that’s holding you back. Over time, you’ll gain financial freedom and peace of mind, knowing you made the right moves in the right order.

Now you have a plan to tackle debt and save money side by side. You’re setting yourself up for a brighter financial future!