pay off debt or save

All together, Canadian households owe $2 trillion in debt! That’s $2,000,000,000,000 in debt. That’s a lot of zeros.

And carrying a lot of debt can even impact your health. Studies show carrying debt causes extreme anxiety and depression. This, of course, can even exacerbate the issue.

So the question is: should you pay off debt or save your money? Let’s explore that.

How Much Do You Already Have Saved?

First, let’s look at how much you already have in savings. Most likely, it’s not that much.

So what happens when a crisis occurs – your car breaks down, your water heater breaks, your dog gets sick? How will you pay for the unexpected expense?

If you have to pull out of your retirement fund or other investments, you don’t have enough in liquid savings.

Most financial experts recommend you keep at least $1,000 saved in cash for an emergency fund. This should be there when emergencies strike.

Otherwise, you’ll have to reach for a credit card that hopefully hasn’t already hit its limit. That’s like taking one step forward and three steps back.

So if you don’t have a $1,000 emergency fund, focus on saving this first.

Unless you fall into the next category.

What Are Your Interest Rates Like?

Before you make a plan, take a look at all your outstanding debts and their interest rates.

Most Canadians are saving over paying off their debt. But this may cost them in the long run if they’re carrying balances with high-interest rates.

On average, most credit cards charge an interest rate of close to 19.24%. But you likely have even higher interest rate credit cards. The main thing to look for is cards that charge interest higher than 25%, or any payday loans.

Interest like these can quickly take a manageable debt to frustrating levels. So before you save for an emergency fund, pay off any payday loans, and pay off credit cards with an APY of 30% or higher.

But you also likely have a mortgage, car payment, or student loans that charge interest rates closer to 5% or 6%. Even though the debts are a lot higher, you don’t need to worry about paying these off as quickly.

How Tight is Your Existing Budget?

Next, let’s sit down with your budget. Where is everything going? How much is left over? Financial experts recommend you put 20% of your take-home pay towards savings.

But if your budget is tight, you’ll likely find it close to impossible to squeeze out this extra 20%. Start with 5% or even 10%, whatever you can manage. The important part is that you start somewhere.

If your budget is tight, focus on paying off your cards with the lowest balance first. This will free up those extra payments that you can either save or put the extra money towards your other debts.

By eliminating your smallest debts, you have some more wiggle room in your budget. This means you can preserve your credit score and worry less if one month comes in tighter than others.

If you can squeeze out 15% to 20% in your budget, put this extra money towards your highest interest rate debt first. This practice saves you more money throughout your debt payment journey.

What’s Your Existing Debt Balance?

How much money do you owe total? To whom do these debts belong? Once you’ve looked at each debt individually, look at the number as a whole. Likely it’s several tens of thousands of dollars.

Are you one of the fortunate few who has less than $10,000 in debt? You may find it more rewarding to pay off all your debt before you focus on your savings even more.

But if you owe $20,000 or more, it’s time to build a more detailed plan. Depending on your interest rates, you’ll need to focus on savings in your plan too.

So to sum it up, here’s how to decide whether you should save your money or pay off your debt. (Hint: It’s usually a combination of both.)

To Pay off Debt or Save? That Is the Question (And It Depends on These Factors.)

Step 1: Write it All Out

Write out all your savings, all your debts, and all your interest rates.

Step 2: Build a Budget

Try to save 20% of your take-home pay. But if you can’t save that much, shoot for as much as you can. Depending on where you’re at in your plan, put this money towards savings or extra debt payments.

Step 3: Pay Off High-Interest Rate Debts

This only applies to payday loans and cards with a rate higher than 30%.

Step 4: Build an Emergency Fund

You need an emergency fund for when (not if) emergencies strike. This keeps you from going deeper into debt.

Step 5: Pay Off Your Debts Starting With the Highest APY (Unless Your Budget is Really Tight)

Organize your debts by the highest interest rate. Pay the minimum payment on each, and throw every extra penny towards your debt with the highest rate.

The exception to this is if your budget is tight. Then it makes sense to pay off the debt with the lowest balance first. This will free up extra money in your budget in case you come up short.

Step 6: What Happens When Your Debts Have Rates Less than 8% APY

When you’re down to your biggest debts with the lowest APY (home, car, student loans) go back to savings. Build up your emergency fund to 3 to 6 months of expenses.

You can also split how much you’re putting towards debt payments in half. For example, if you were putting forth 20% of your take-home pay towards debt, now is a good time to save more. You may want to put 10% towards savings and 10% towards debt payments.

Step 7: Debt Free (So Save!)

When you’ve paid off all your debts, put all that extra money towards your savings. Relax, knowing you’re debt-free!

Should You Pay Off Debt or Save Your Money? Now You Know How to Decide

Deciding whether to pay off debt or save your money depends on how much you already have saved. Also, consider your interest rates and how big the total debt balance is.

But the tips above should help you create the best plan to save and pay off debt wisely.

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