When trying to pay off debt, you may be faced with a difficult question: do I put money in savings or pay more on my loans? While each situation is unique, there are factors that should be considered before you make a decision. Consider these three factors when debating whether to pay student loans or set aside some spare cash.
Interest Rate
If you have a high interest rate that isn’t tax-deductible, you will want to pay off your loans before saving. Laurie Itkin, a financial adviser and wealth manager at Coastwise Capital Group in La Jolla, California says, “You don’t earn much, if any, interest on your savings, yet you have to pay interest on your debt. If the interest you pay is higher than the interest you earn, you are losing money.”
To figure out how much your debt will cost you over a year, make a list of all your loans. Calculate and include auto loans, mortgage, credit card debt and anything else on the books. Next, write down the interest rate on each one. Multiply the debt cost by the interest rate to figure out how much extra it cost you a year. For example, a $12,000 car loan at 5% costs an additional $600 a year. Next, figure out how much your savings will earn you for a year. Take the total currently in your account and multiply by the interest rate. More often than not, the interest rate of your debt will cost you more money than your savings can earn.
Current Emergency Fund
Do you have enough money in the event of an emergency? Losing your job or being hit with a load of unexpected expenses can force you into a financial situation. It could take you years to recover. Most financial experts say you should save between 3 and 6 months of living expenses in the event of a job loss or other unexpected expenses. If you currently do not have an emergency fund, you may want to focus on creating one to secure yourself in the event of an emergency. While you are saving, continue to make the required monthly payments on your debts.
Expected Expenses
What do your plans look like for the near future? If you have plans that will require a lot of cash quickly such as a long vacation, starting your own business, buying a car or house, or getting married, then you might want to focus on building up your savings beyond just your emergency fund. By paying for expensive items in cash, or making a larger cash down payment, you can avoid adding debt to your existing amount.
Whichever path you choose, consider using a budget planner spreadsheet to track your expenses and help you analyze where to make adjustments to better help you achieve your goals.
