Are you often thinking: “Should I Save or Pay off Debt First? Use this article for guidance or tips to help make your decision easier when it comes to investing your money.
Source: Pixabay
Consumer debt reached a new record of more than $4.31 trillion in the second quarter of 2021. In July 2021, U.S. consumer debt increased with a rate of 4.7%, which is over $4.33 trillion. The debt of spending consumers did drop in relation to the COVID-19 pandemic, but it has now got back to pre-pandemic numbers.
Debt is a big issue for especially Americans. The recession that hit the world 15 years ago was the reason for millions to become unemployed. Then a period of good recovery got things looking a lot better. Suddenly, the COVID-19 pandemic came and made everything difficult for the economy again. Many people have been forced into bankruptcy or mortgage, and now they are not able to pay their debts or feed their families.
Debts are not a new thing or idea that suddenly appears in America. Debt gives an opportunity to buy a house or a car, it can send kids to college, and in general, it provides things that we need in the present, but it can be paid for in the future.
There are several different ways of legal protections for paying back the debts, due to creditors and protection from illegal debt institutions. There are a small number of federal regulations and numerous states use all of them.
Source: Statista
Main Debt Categorizes
Most Americans have some kind of debt in their lives. Nevertheless, not all debts are made equally and some of the debts are considered better than others. Well, debt appears in different types of forms, all personal debts are categorized through some main types, including secured debt, unsecured debt, revolving debt, and mortgages.
Explained in short:
- Secured debt requires some form of collateral, while unsecured debt is solely based on an individual’s creditworthiness.
- A credit card is an example of unsecured revolving debt and a home equity line of credit is a secured revolving debt.
- Mortgages are home loans that typically have 15- or 30-year terms, with the real estate serving as collateral.
Most Common Debts/Loans in the US
Americans have a lot of general debt that can be connected to three things: credit card debt, auto loans, and student loans.
Credit Card Debt
There are a lot of good reasons to like credit cards: You can build up credit, it is possible for you to pay for purchases, as well as earn rewards. The research found that 90 percent of U.S. adults have a minimum of one credit card, and about 75 percent of adults carry a balance each month. Moreover, the average credit card balance is $5,315.
Carrying a credit card balance might not be the best idea because of growing interest charges, but in total, the credit card balances are moving the right way. Credit card debt has been through one of the largest drops from 2019 to 2020, decreasing by 14 percent. Furthermore, the percentage of consumer credit card accounts fell by 29 percent in 2020.
Source: Pixabay
Car Loans
Almost every car shopper does not have all the cash to pay upfront when buying a new vehicle, so they get an auto loan and pay the balance later. This is the second-most popular type of loan, as two-thirds of U.S. adult citizens have a minimum of one auto loan. The normal balance of this kind of debt is $19,703 and is rather stable with the 2019 numbers. The percentage of auto loan accounts dropped by 22 percent in 2020.
Source: Pixabay
Student Loans
Student loans help many Americans each year to pay for a great education. The average balance for this kind of debt was $38,792 in 2020, which is representing a nine percent growth. This increase is at least partly credited to the suspension of student loan payments, both from the federal government and from private student loan creditors. When fewer debtors are paying for their student loans, then the average balances will increase as new loans are added.
Source: Pixabay
Should I Save or Pay off Debt First?
It is always a challenge to select between saving and paying off debt. Are you struggling with the same choice and think it is difficult to decide whether to allocate the funds or bonuses into your budget? Then you are definitely not alone. Household debt separate from housing costs rise steeply to the highest level in 16 years in 2020, at the same time, the household savings increased as well, which has not been seen since 1975.
So is it a better idea to pay off debt or save? Well, a lot of people are actually doing both, but let us look at the things to consider when you need to decide which one is the most important.
Start Saving Now
Paying off debt is essential, but the same is to build up financial resilience and organize for your future. Consider these two tiny steps before handling your debt:
Build Up an Emergency Fund
Nowadays, even a small emergency fund will help you to keep finances more stable, when an economic crisis comes. Families with around $250 to $750 in savings are almost 30% less likely to miss a housing payment compared to other families with fewer savings.
So it might be a good idea to build up an emergency fund with about $500 to start, and then growing your money from there.
It could be a good idea to use a budgeting calculator that helps you allocate your money to build up your savings. By using this method, you will find half of your income goes to necessities, like housing, groceries, and transportation. Around 30% might go to needs, like entertainment and eating out. The last 20% will probably go to paying debt and save up money. Depending on the amount of debt and income, you might want to cut some of your “wants” to bring up your debt payments and savings faster.
Source: investopedia
Clean Up Toxic Debt First
When you have established your savings, it is always a good idea to pay attention to paying off your toxic debts, like payday loans, credit cards with rates of more than 15%, car loans, and rent-to-own payments.
Focus on these kinds of loans at first as their high rates might take your entire budget and make a bad spiral of debt.
A payoff debt calculator will make it easier for you to see when you will pay out all of your debt. This is just by looking at your current payments, and how you can pay debt faster by paying more each month.
Tip: Check out the different payoff debt methods online, so you can decide which one is the best debt calculator for you.
Furthermore, it is important to know when you need to ask for help. You might need assistance if:
- It is difficult for you to meet your minimums and don’t see a way to settle your debt within the next five years.
- Your unsecured debt is larger than half of your income.
More Savings and Remaining Debt
When you have control of the toxic debt, then you can go back to establish some better cash reserves and savings for retirement, while you work on paying off the rest of the debt.
If you are putting a minimum of your money into your savings you might as well add a bit more. Work on saving 15% of your regular income, so there are savings towards retirement as well.
Student loans, credit cards, or auto loans with rates of 15% or below, are perhaps easier forms of debt to handle. But it will still be essential to create a plan of paying back what you owe.
Bottom Line
The best solution might be to find a balance between saving money and paying back your debt.
Perhaps you are paying more in interest than you should, but to have savings if unexpected charges came up will definitely keep you out of a bad debt spiral.
Furthermore, having the necessary savings will give you peace of mind. Certain people are unlikely to feel secure knowing that any strategy could cause their savings to drop beneath a specific number or level. For people like that, saving money and paying debt at the same time may be the best method.