2020 has proven to be a difficult year in more ways than one.
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| Midsection Of Businesswoman Holding Credit Card And Bill While Working At Desk. | © Provided by Bankrate |
By Liz Hund, Bankrate
The coronavirus pandemic
in particular has shone a light on the many economic disparities in
America and has left millions of Americans struggling to make ends meet.
Many have found themselves tapping into their emergency savings - or
worse, wishing they had some.
On
top of this, 34 percent of millennial credit card holders said that
they had fallen further into debt as a direct result of the pandemic,
according to a recent CreditCards.com survey, a sister site of Bankrate.
Juggling
debt and worrying about building your savings at the same time can
really weigh on a person. While there's no right answer for everyone,
here are scenarios for when each choice - paying down debt or saving -
makes more sense.
When to make saving priority
There are a number of good reasons to save first and pay down debt later.
Some of the top reasons include:
- Debt with a very low interest rate
- Access to an employer 401(k) match program
- No emergency savings
If
you have a credit card or other debt with a very low interest rate, it
may make sense to save first, says Melissa Joy, a certified financial
planner and founder of Pearl Planning, a financial planning and wealth
management practice in Dexter, Mich.
Another situation where it makes sense to save before paying off debt is if you have access to a retirement savings plan through your job, especially if there's an employer match available.
Try to contribute at least enough to get the maximum employer match. If
you aren't doing this, you are effectively turning away free money.
And putting off saving for retirement until you are debt-free could cost you your most valuable asset: time. With compound interest, even small contributions to your retirement plan can grow significantly.
However, the top reason to make saving a top priority over paying down debt is to build your emergency fund.
Without some money saved up, you could simply wind up adding to your
credit card debt in order to pay for an unexpected car repair or a trip
to the emergency room.
"If you don't have any savings, focusing
solely on paying debt can backfire when unexpected needs or costs come
up," Joy says. "You might need to borrow again, and debt can become a
revolving door."
What could go wrong? Well lots of things,
especially now. The importance of this fund has been highlighted in the
age of coronavirus: 23 percent of Americans' said their biggest financial regret during this pandemic was not having enough emergency savings to weather the crisis in a recent Bankrate survey.
Saving
first - and building up a decent emergency fund - could spell the
difference between weathering tough times and winding up in bankruptcy
court.
How much to save
Experts recommend building an emergency fund
of three to six months' worth of expenses and stashing it in a savings
account. Some even recommend putting enough cash in the bank to be able
to pay your expenses for an entire year.
But you have to start
somewhere. Aaron Graham, a CFP with Abacus Planning Group, Inc. in
Columbia, S.C., suggests starting first with a goal to cover a single
month's expenses.
"There is no excuse for not saving for these
emergencies," Graham says. "It's not a question of if they will happen,
but when; plan accordingly."
While you are at it, shop around with different banks in order to get the best possible rate on your savings.
Saving in the age of coronavirus
For those who are fortunate to still have an income and the ability to work from home, this could be a great time to build your savings.
“Now
that Americans are spending more time at home, they should consider
their new patterns. Take a look at cell phone and cable bills and think
about whether you need to adjust your plan to avoid overage fees.” says
Lindsay Sacknoff, head of consumer deposits, products and payments at TD
Bank. “There may also be bonus services you've previously been paying
for that can be reconsidered now that you have more time at home, like a
home cleaning service or babysitter. These expenses can now be cut out
from your budget so you can save that extra money.”
On the other hand, if you are facing a reduced income then you may want to reach out to your lenders and providers to discuss temporary payment relief options.
"It can be easy to assume that whatever amount appears on your monthly bill is set in stone, and for some municipal utilities like water and electricity that may be the case," says Tony Wahl, a credit and loan expert at Credit Sesame in Mountain View, California. "However, sometimes subscription services like telephone, cable and internet service can be negotiated. This can help prioritize your bills and free up some of your available cash to be added to your savings."
Interest rates are very low
right now, which typically means two things: people don't have as much
incentive to save, but they do have more incentive to buy or get a loan.
However, you shouldn't let these low rates discourage you from saving
because if there's one thing we've learned from the coronavirus crisis, it's that hard times come when you're least expecting them - prepare for that next emergency now.
When to prioritize debt repayment
When you have high-interest consumer debt, paying it down first can help you solve ongoing problems with managing your money.
You'll
get a guaranteed return by cutting your interest payments. It's
typically more than you'd earn in the stock market and definitely more
than you'd earn in a savings account.
To get started with repaying your debt, here are four things to take a look at:
- Calculate your expendable income (what's left after taxes, bills and food)
- List all your regular expenses (even if they're periodic) and see if there's anything you can eliminate
- Create a budget based on that number and include paying down debt as a significant part of the equation
It
also helps to identify what your financial goals are, so you can
prioritize them in your budget. In this case, we're assuming that paying
off debt is your number one priority. By accounting for a monthly
repayment in your budget, it will better ensure that you still have
money leftover for necessities.
Another option to look at is a credit card balance transfer. This can allow you to consolidate all of your credit card debt onto one low-rate card and save you money on finance charges.
Tara
Alderete, director of education and community at Money Management
International, says that it usually makes sense to prioritize debt
reduction, but there are exceptions.
"If you already have adequate
savings in your emergency fund, you may want to focus on quickly
eliminating debt," Alderete says. "However, if you find yourself making
only minimum payments on debts with extremely high-interest rates, those
debts may be causing you to lose money and preventing you from
achieving your overall financial goals, and you may want to focus on
paying off that costly debt.”
As Alderete sees it, an important
part of building a budget is focusing on your priority expenses first,
so that you can free up money to put toward a debt reduction plan while
hopefully still being able to contribute to an emergency fund.
When
deciding whether to pay off tax-deductible debt versus saving, don't
worry about losing a tax deduction if you pay off the debt. The
deduction is probably worth less than the annual interest you would have
paid on the loan.
The ideal approach
The best solution could be to strike a balance between saving and paying off debt.
You
might be paying more interest than you should, but having savings to
cover sudden expenses will keep you out of the debt cycle.
Additionally,
having sufficient savings provides peace of mind. Some people are
unlikely to feel at ease with any strategy that causes their savings to
fall below a certain level. For them, saving and paying down debt at the
same time might be the best approach.
"Every savings vs. debt
situation is case by case," says Aaron Clarke, a wealth advisor at
Halpern Financial in Ashburn, Va. "If a client has surplus cash flow,
the best thing to do is "walk and chew gum" - paying down debt and
saving at the same time."
See more at Bankrate
