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Things to Consider Before You Use Savings to Pay Off Debt

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Things to Consider Before You Use Savings to Pay Off Debt

It’s the chicken or the egg of the personal finance world: should you prioritize building up savings or paying off debt? It really depends on your individual situation. But if you’re going to tap into your savings to pay off debt, there are some questions you should ask yourself.

4 questions to ask yourself before using savings to pay off debt

Where is the savings coming from?

Are you saving for a down payment for a house? Starting a college fund for your kids? You shouldn’t touch those to pay down your debt, especially if your debt has relatively low interest rates.

You also want to avoid tapping into your retirement savings to pay off debt. If you use your retirement fund to pay down debt now, what will you have when you retire?

Do you have enough emergency savings?

If you don’t already have an emergency savings fund, that should be your top priority. You want to have enough money to pay for at least three months’ worth of expenses in your emergency fund (closer to six if you really want to be diligent).

If you’re tapping into that fund to pay your debt and dipping below the three-month mark, you should consider alternatives. If your emergency fund is well stacked, though, you can scrape some off the top until you reach that three-month threshold.

How much debt do you have and how high are your interest rates?

On top of the amount of debt and the interest rates you’re dealing with, it’s important to consider the types of debts. Certain installment loans like mortgages and federal student loans have fairly low interest rates.

The current 30-year fixed mortgage rate is hovering just below 3%, while the average federal student loan interest rate ranges from 2.75% to 5.30%. In these cases, you’re probably hurting yourself more by using your savings to pay down these debts.

If you’re looking to pay your student loan faster, a better option would be looking into refinancing options such as Earnest refinance, as you will be able to get a better interest rate based on your career trajectory and financial management.

But in the case of credit cards—where the average interest rate is roughly 16% and can get as high as 36%—you might benefit from using your savings to pay down your credit card debt to avoid accruing massive amounts of interest.

Can you expect to receive additional funds in the near future?

Are you getting a raise? Expecting a substantial bonus? Picking up a side hustle? Getting that tax refund?

If you tap into your savings to pay down debt but can quickly replenish it with funds, this might work for you. But if you’re taking this approach, make sure that money is definitely coming your way.

How to avoid using savings to pay off debt

Instead of immediately turning toward what you have saved to pay down debt, consider coming up with a debt repayment plan or strategy that fits with your financial goals.

Debt snowball or debt avalanche

You could employ the debt snowball or debt avalanche methods, which take similar approaches with near-opposite starting points.

With the debt snowball method, you prioritize paying off your lowest balance first by throwing as much as you can at it while still paying the minimum on your other debts. Then you roll that over to the next-smallest balance and continue the cycle until you’re debt-free. This approach helps you build momentum with quick wins along the way.

The debt avalanche method does the same thing expect you start with the highest-interest-rate debt and continue down to the lowest interest rate. It might take longer to pay down your first debt, but in the long run, you’ll likely save more on interest if you’re able to keep up with this approach.

Debt consolidation

A debt consolidation loan or balance transfer credit card can help you streamline multiple debts into a single monthly payment. With a debt consolidation loan, the goal is to get a lower interest rate overall, while most balance transfer cards come with a 0% introductory APR offer for at least the first year. You’ll likely need a good to excellent credit score to qualify for a balance transfer card, though.

By Casey Musarra

Casey is a reformed sports journalist tackling a new game of financial services writing. Previous bylines include Newsday and Philly.com. Mike Francesa once called her a “great girl.”

 

We are a team of writers passionate about innovation and entrepreneur lifestyle. We are devoted to providing you the best insight into innovation trends and startups.

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