What to Do First— Build Savings or Pay Off Credit Cards

On paper, paying off your credit card debts first before building your savings fund is the better choice. If the interest you are paying is higher than the interest you are earning, then you are wasting money.

However, it is not that simple in real life. You need to consider several factors before making any financial decisions. Getting rid of your credit card balances might not be the best option for everybody.

For instance, you might be able to pay off your debts, but you don’t have an emergency fund. If an unexpected expense comes along, you would take on more debt than you previously owed.

Many people don’t know what to do when they face this decision. That’s why they don’t fully commit to saving or repaying their credit cards.

Presented here are some situations that explain when to build up your savings first and when paying off your consumer debts first makes more sense.

When to Save First

There are several reasons why it makes more sense to build up your savings fund first before paying off your debts. However, the most important reason is having an emergency fund. If you don’t have any savings and only focus on repaying your outstanding balances, you will just need to borrow again in the future to cover unexpected needs.

Your emergency fund acts as a backup so that you don’t rely on plastic. Financial experts suggest having between three and six months’ worth of your regular expenditures in a savings account. Look for an account that provides the best return.

Another scenario in which it is more logical to save first is if you have a 401 (k) plan through work, and your employer is going to match your contributions. If that is the case, then consider contributing to get the maximum match from the company.

Time is also one of the things to pay attention to when making the decision between saving or paying your credit cards off. When you start putting aside money for your retirement early, it can grow significantly, due to compound interest.

Create a Plan and Stick to It

You need to come up with a plan that addresses your credit card debt and savings at the same time. That way, you can optimize your money. The plan allows you to prioritize one aspect of your financial goals.

Experts agree that you should set aside 20 percent of your income for debt payments and savings. How you divide the amount will depend on your priorities. No matter what you choose to prioritize, though, make sure you stick to your plan.

When to Pay Credit Cards First

If your credit card charges, you a high-interest rate, you should consider paying it first. Doing so can help improve your cash flow issues. You get better returns by getting rid of a high-interest debt, especially if the monthly installments are more than what you earn from a savings account.

Before repaying your credit card debt, however, you should first know how much money you can set aside for the payments. Then incorporate that amount into your budget.

If you have more than one credit account, you should consider consolidating them into a balance transfer account, which will allow you to save money on finance charges because the much lower rate.

Choose Both

Another solution to the problem is to find a balance between the two options. You might pay more interest, but at least you have a fund to cover unexpected expenses such as home repairs. That way, you can avoid getting into the debt cycle.

Depending on the status of your finances, it might make more sense to do both at the same time. Having adequate savings gives you peace of mind. If you want to understand your options better, consult an accountant who can provide you with a complete analysis of your current financial status.

Even if you don’t have enough savings, you can still choose to do both. After you list your fixed expenses, you can divide your income between paying down your unsecured loans and saving. This method allows you to build up savings steadily over time, and at the same time, achieve your financial goals. Once you have enough money in your emergency fund, you can then focus more on eliminating your financial burdens.

It might take you longer to pay off all your credit cards and for your savings account to grow using this method, but by doing so, you would achieve both goals in the end. You can increase your payments once you already have adequate funds to cover emergencies that might come in the future.

Importance of an Emergency Fund

You might think that you are merely wasting your money if you let it sit in the bank and earn only a small amount of interest. However, the fund is there for one purpose— and to have money for emergencies. You never know when you’ll absolutely need cash.

Your emergency fund isn’t growth money. It is not a retirement fund, which needs to keep up with the inflation. Its sole purpose is to prevent you from having to borrow or sell assets when you face unexpected expenses.

You need to have some type of savings if you want to get out of debt. If you don’t, and you will face a financial problem in the future, you might just end up going deeper into debt. The question is not to save or not to save, but how much you should save.

If you don’t have job security, then you need savings that can help you cover expenses while you are looking for another job. You might think that you can find another source of steady income quickly, but you should be prepared when the opposite happens.

You can start building an emergency fund of $1,000 to $1,500 that can cover typical emergencies, such as home repairs. Once you have that amount, stop saving and use your extra cash to get rid of your debt.

Keep in mind that what works with one person might not work with you. No matter how you handle the problem, it is important you know your goals and decide which path you are going to choose. There should be a balance, whatever your decision might be. That way, you can achieve your goals within incurring additional financial burdens.

While it might seem to be a complex problem, it is actually a simple process. All you need to do is make some sacrifices and work harder to pay off credit card debt, so you can build up your savings.