Pay Off Debt or Save Money First?

Like so many others, I graduated college owing a huge amount of money: I had thousands of dollars in student loan debt, hundreds of dollars in credit card debt, and a pretty bad credit score to top it off.

Starting life post-college owing a lot of money is pretty common, though. A recent report from the Project On Student Debt found that 1.3 million students graduated college with debt in 2012 (that’s 71% of all graduates!), and the numbers seem to just be going up.

If you’re in this predicament, you may be wondering whether it’s better to start paying off your debt or saving money for retirement or a rainy day. Here are five questions you should ask yourself to decide if it’s better to pay off debt or save up:

1. Do You Already Have Savings?

Everybody should have some money put away in a savings account in case of a medical emergency, an unexpected expense or even a lost job – and having an emergency credit card is not the same thing.

Financial planners all make different recommendations for a starting savings account, but it’s generally advisable to have enough on hand to cover about three months’ worth of expenses. For some people, it can take a long time to save that much money, so start by taking half a year, or ideally less, to build up to a solid $1,000.

You don’t want to rely on credit cards because they’ll just add onto your debt and interest rates if you use them for an expensive emergency.

2. Will You Need a Lot of Money in the Near Future?

If there’s something in the near future you’ll need a large quantity of money for, it may be better to save first and pay off debt later. One big lump sum to keep in mind and save for is if you’re moving to a new place.

Between application and move-in fees, security deposits and first month’s rent, you’ll need quite a bit of money saved up. Whether it’s a new place, saving money for a new car, or even saving up to start a business, you should take care of those expenses first before really tackling debt.

3. What Are Your Interest Rates?

Take an afternoon to do some budget math. How much are the interest rates on each loan or line of credit you have? If you multiply them by the amount you owe, you’ll know how much that debt is costing you per year.

On the other hand, how much are you gaining from interest in your savings accounts or investments? If you’re making more money by saving than what you’re losing on your debts, it may make sense to save up faster than you’re paying off your loans and credit cards.

4. How’s Your Credit Score?

New credit is already bad, but a lot of debt on top of it can make your score even worse. If you’re struggling with a low credit score, putting more money toward paying off debt probably makes better sense.

Good credit is important for a lot of reasons, and it takes time to build up. Even if you’re thinking of buying a car or an apartment or opening a business in a couple years, you should start getting your credit score up now.

5. What’s in Your Financial Future?

Are you expecting any large sums of money in the near future? For some people, tax returns are a good way to knock a quick hole in their debt or put a few hundred in a savings account, for instance.

If you have some extra money coming in, try to plan for it. It can be tempting to spend, especially if you’re on a tight budget, but resisting now will pay off later. And if you need a little extra motivation, just think how excited you’ll be when you’ve worked hard enough to whittle your debt down to a manageable sum, and have a solid nest egg saved up to boot.

For most people, paying off debt and saving money shouldn’t be an either/or situation. Use these questions to determine which you should be doing more of at the moment, but try to put at least a little of each paycheck in both categories to set yourself up for the future.

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