5 tips for balancing saving and paying down debt

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In a Nutshell

You don't have to choose between paying off loans and building your savings. Make progress in both areas by devising and sticking to a financial plan that inspires you.
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Should you save or pay down debt? If you choose to save — and that includes investing for retirement — will you be weighed down with debt for years? If you decide to pay down debt, will you ever be able to save enough?

You may wrestle with these issues, even to the point of feeling paralyzed that choosing the wrong path will lead to financial ruin. Relax. Pursuing more than one financial goal at a time is doable. Here are tips to balance saving and paying down debt.

  1. Take care of the basics
  2. Commit to controlling variable expenses
  3. Focus on what motivates you
  4. Automate your finances
  5. Decide what to do with extra cash

1. Take care of the basics

Start by creating a basic budget that covers your major financial obligations. Be sure to factor in minimum payments on any debt you may have, including but not limited to:

This should help you make steady progress toward reducing your loan balances.

At the same time, begin building an emergency fund so you’ll have the cash you to handle unexpected happenings in your life such as a job loss or bills relating to a family illness. Save an amount that fits your budget, even if it’s just $25 monthly. Keep adding to the balance until you have accumulated at least three to six months’ worth of living expenses required for things such as groceries and rent. After establishing this fund, you can consider directing extra money either to debt payoff or long-term savings.

You may also want to consider contributing enough to your 401(k) account to receive a full employer match if offered. This move could allow you to accelerate the growth of your retirement savings.

2. Commit to controlling variable expenses

Katie Brewer, Certified Financial Planner™ (CFP®) and president of Your Richest Life Planning in Dallas, Texas, recommends establishing firm limits for variable expenses, or anything that is “not a bill, loan or payment.” For example, dining out, gifts and entertainment would all fall under this category.

By controlling these costs, you may be able to free up additional funds for debt repayment, savings or both.

Brewer often recommends the following approach to her clients:

  • Look at your current spending for variable expenses. Again, these are non-essential things you buy such as movie tickets, restaurant meals and toys for your nieces and nephews.
  • Establish a reasonable monthly spending limit. This dollar amount will vary by person but should be a goal that is attainable based on your buying habits. The number should give you flexibility to make purchases as desired but not so much freedom that you’ll spend excessively.
  • Set up a checking account and funnel variable expenses through this account. When the account balance is depleted, stop spending. Alternatively, charge these expenses (and nothing else) on a specific credit card, then evaluate your spending and make adjustments until you consistently achieve your goal.
  • Monitor expenses and modify spending to sync with established limits. There are many tools and apps available that can help you with this.

3. Focus on what motivates you

After you’ve taken care of the basics and have learned to control your spending, your next step can reflect personal preferences. Brewer encourages her clients to use the financial strategy that sparks momentum and is sustainable over time.

For example, you may get more satisfaction from quickly eliminating a small loan with a relatively low interest rate as compared to slowly reducing a large credit card balance with a high interest rate, even if the latter may save you more money in interest. Alternatively, you could be inspired to aggressively grow your savings and retirement accounts. Take actions based on what motivates you to stay disciplined and make the most financial progress.

4. Automate your finances

As soon as you’ve decided how to allocate your money, consider automating as much as possible. For example, you may be able to set up automatic payments on your student loans, direct deposits to your savings account and contributions to your 401(k) plan.

Through automation, you can avoid second guessing your saving versus paying-down-debt decisions and the stress that often comes with continually analyzing your financial situation.

5. Decide what to do with extra cash

During the year, you may earn or receive extra cash, whether from a side income, a year-end bonus, a large refund from the IRS or a large holiday gift.

Before this money lands in your hands, consider deciding where it will go. Will you make additional loan payments with any side income you earn? Have you decided to fund an IRA with any cash gifts you receive? Whatever course of action you choose, plan ahead for windfalls.

Bottom line

Sure, you may want to get rid of debt as quickly as possible. By concentrating on debt payoff, you could save hundreds or even thousands of dollars in interest charges over the life of your loans. You could also improve your debt-to-income ratio, which might help your chances of qualifying for a car loan or home mortgage.

But you could also benefit from building your savings and paying down debt at the same time. With this strategy, you should have cash available for unexpected expenses. In addition, you may be able to reduce your income tax liability by contributing to a 401(k) and IRA or continuing to deduct interest associated with your mortgage and student loans. Finally, by saving and investing now, you should be able to take advantage of compound interest over a longer period of time than if you waited until you were debt-free.

You don’t have to choose between paying off loans and building your savings. Make progress in both areas by devising and sticking to a financial plan that inspires you.