Did you know that the average debt load for an American household (including mortgage) is $101,915? Other types of loans are included in that number: student loans, credit cards, car loans, personal loans, and medical debt.  

Even if you exclude mortgage debt, the numbers are still striking: the average non mortgage debt is $26,532 for individuals between the ages of 30 and 39, and $27,838 for those in the 40-49 age group. No matter which combination of loans a person has, that level of debt can feel like a huge burden. 

What about you? Is your debt close to the average for your age range? Even if you owe more or less than the average, debt is likely a factor in your financial life. And you may wonder when (or how) to pay down debt.

The Challenge of Paying Off Debt vs. Saving Money

You may feel overwhelmed when you think about trying to pay down debt. And if so, you aren’t alone — over one-quarter (28%) of Americans believe it will take them five years to pay off their credit card debt. And 6% believe they’ll never be able to pay it off.

You may be looking at your debt statements and wondering if you should put all your extra monthly cash toward those balances. Or should you still save some so you have enough cash for a rainy day? You’ve also probably worried about going back into debt if you don’t have enough cash saved for emergencies. But when all of your money is going to debt repayment, how can you save?

Thinking this way is a vicious, stressful cycle. And it doesn’t help to hear popular money personalities arguing that you should just focus on one (or the other) — especially when those people have no insight into your personal financial situation.

We’re not going to tell you that one way is always better than the other. Because the truth is that the answer isn’t the same for everyone. Instead, let’s cover some of the factors that can influence this choice. Then, you can use that information to decide which option is right for you and your family.

Interest Paid on Debt vs. Interest Gained on Savings

Unfortunately, debt accrues interest. While some car loans may have a 5% or lower interest rate, those lower rates aren’t available to all borrowers. And some credit cards can have an annual percentage rate (APR) of over 30%. 

On the other hand, some savings accounts have a minimal interest rate of less than 1%. Other high-yield savings accounts can offer over 4% annual percentage yield (APY). Alternative forms of savings, such as Certificates of Deposit (CDs), may offer even higher APY numbers, but they often have restrictions on when you can access your cash.

With this in mind, it’s easier to see the “mathematical” impact of debt vs. savings. While you may be accruing 3% on a savings account, you may also be losing money to a 30% credit card interest rate, which means your savings account gains will never cover your credit card losses.

So really, the question of savings vs. debt repayment isn’t, “Should I pay down debt or save?” Instead, the question might be reframed: “How can I maximize my savings interest while minimizing my debt interest?” 

Action item:

Take a minute to look at the interest rates on your credit cards, student loans, and other debts. Is there a percentage that makes you cringe? That might just be the best place to focus your efforts. On the other hand, if you can save some cash in a high-yield account while still paying down your lower-interest debts, that may be a good option for you. 

But there’s more to all of this than math.

family sitting on dock

Don’t Forget Your Debt and Savings Goals

There’s another element that gets glossed over in the oft-repeated “debt is dumb” message: your financial goals. While it’s generally best to pay down debt in a timely manner, there may be instances where paying more toward your debt can actually harm your overall goals. 

Take, for example, a couple who really wanted to focus on funding their future travel goals. While they may both have student loan debt, they have a certain amount of flexible income per month and want to save as much of that as possible for the places they want to visit before having kids. For them, steady debt repayment and a more aggressive saving plan may fit best with their needs.

On the other hand, a young woman who wants to reach financial independence by age 40 so she can work only when she wants may benefit from the opposite approach. In her case, paying down debt as fast as possible and then saving aggressively may make the most sense. 

Action item:

While the numbers or recommendations may advise one thing, you should always consider what you really want your money to do for you. (Just don’t stop paying down those balances.) 

Figure Out Your Liquid Cash Needs

Last but not least, consider liquidity in your decision. Liquid assets are assets that can be bought and sold quickly, and whose value doesn’t change drastically over time. Cash is the easiest example of a liquid asset, and a bar of gold is essentially the opposite. 

With this definition in mind, consider any upcoming events or milestones that may require a lot of cash. Maybe you want to adopt a baby, buy a house, or fund your trip to Europe. 

If you realize that you have a need for liquid cash in the near or upcoming future, it may not be best to dump all your cash reserves into repaying your debt. You’ll still need to make some debt payments each month, but you may consider delaying additional payments until the reason for your liquid cash needs has passed.

It’s YOUR Life, So Do YOUR Math

You’ve probably heard that you need to save $1,000 in an emergency fund before you start paying down debt. This emergency fund is a great idea, especially for people who are in debt because they lacked savings to handle a previous emergency. 

But the truth is, 37% of Americans can’t cover a $400 emergency, let alone a $1,000 one. And how many emergencies do you know of that cost less than $1,000? A trip to the ER, a broken radiator, or a lost job can all cost more than $1,000. 

This is not to say that you shouldn’t be building your emergency fund — of course you should. The point is that money decisions are not one-size-fits-all. The balance between paying down debt and saving may be different for each person, and that’s OK. 

Do your own math (interest accrued vs. interest paid), and take into account your own goals so that you can create a debt repayment plan that makes you feel empowered, not stressed or stupid. And remember, you don’t have to follow cookie-cutter advice, just because it comes from a popular financial personality.

Would you like to get customized financial advice for your unique situation? That’s what we do here at Guiding Wealth. No blanket statements or judgment about your debt-to-income ratio. Instead, we work with you to make a plan that aligns with your financial goals and values, so you can move forward with confidence. Schedule a consultation to get started.