Should I Pay Off Debt or Save Money First?
Understand the simple rules for deciding whether to tackle debt or build savings first, and how to find the right balance for your situation.
The Simple Rule Most People Get Wrong
The math is actually straightforward, even though the emotional decision feels complicated. If the interest rate on your debt is higher than the return you would earn on savings or investments, paying off the debt first wins mathematically. If your savings would earn more than your debt costs, saving wins.
In practice, most high-interest consumer debt — credit cards at 20% APR, for example — easily beats anything you could earn in a savings account or even a diversified investment portfolio over short time periods. The stock market averages roughly 7% to 10% per year over long periods, but that is an average with significant volatility year to year. A credit card charges 20% with no volatility — it compounds against you every single month.
The exception most people forget about is an emergency fund. Before aggressively paying down debt, it is worth having at least one month of expenses saved in cash. Without that buffer, any unexpected expense sends you straight back to the credit card, undoing your progress.
When to Pay Off Debt First
Prioritize debt elimination when you have high-interest consumer debt, meaning anything above roughly 7% to 8% APR. Credit cards, payday loans, and high-rate personal loans all fall into this category. The guaranteed return from eliminating 22% credit card debt is far better than any investment you are likely to make in the same timeframe.
Also prioritize debt when the monthly payments are causing cash flow problems. If debt payments eat such a large portion of your income that you cannot cover regular expenses without stress, reducing that load should come first. Financial breathing room has real value beyond just the math.
Consider your mental state too. Some people find carrying debt deeply stressful in a way that affects their sleep, relationships, and work performance. If being debt-free would dramatically improve your quality of life and motivation, the psychological benefit has real value worth considering.
When to Save First
If your employer offers a 401(k) match, contribute enough to capture the full match before doing anything else. An employer match is literally free money — a 50% or 100% instant return on your contribution. Nothing else in personal finance competes with that.
Low-interest debt like federal student loans or a mortgage with a rate below 5% does not require aggressive payoff. The expected long-term return on investing is higher than the cost of those loans, so putting extra money into a retirement account or index fund typically makes more financial sense than paying off low-rate debt early.
Once you have your emergency fund covered and you are capturing any employer match, you are in a position to make a more nuanced decision about where extra money goes each month.
The Middle Path That Works for Most People
For most people in the middle — carrying moderate debt but also trying to build a future — a split approach works well. Pay the minimum on lower-rate debt, throw extra money at high-rate debt, and simultaneously contribute at least enough to get any employer match on retirement savings.
A simple framework: first, build a small emergency fund of one to three months of expenses. Second, contribute enough to retirement to get the full employer match. Third, attack all debt above 8% APR aggressively. Fourth, once high-interest debt is gone, split extra money between retirement savings and lower-rate debt payoff based on your preference.
There is no perfectly optimal answer that works for everyone, because personal finance is as much about behavior as it is about math. The best plan is one you will actually stick with over years. Pick an approach that feels achievable, automate what you can, and adjust as your situation changes.