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Which Is Better: Building Savings Or Paying Down Your Debt?

Mar 2, 2008
Many people find themselves uncertain whether it is a wise course to add money to their savings accounts or to standing investments while trying to pay off their outstanding debts. The essence of the question is really about whether this makes any sense. The answer is sometimes far from simple and requires an examination of the individual's circumstances rather than some ready-made solutions. The difficulty lies in the fact that most people try to do both regardless because it they have important reasons for their savings and investments. Retirement, a child's college tuition, and the purchase of a new home are all powerful incentives to put away the money rather than pay off the debt.

At the same time, there may be some form of answer for those who still want to know. What it really comes down to is learning how to identify and separate your good debt from your bad debt. You might wonder, "What do you mean by good and bad debt; isn't all debt a bad thing?" While it may seem strange, there are some forms of debt that can be a good thing at least to a point. Some examples of bad debt include credit card debts and high-interest loans. Good debt includes such things as mortgages and student loans.

This relates to saving money because it should make sense that the bad debt should be dealt with before you seriously concentrate on your savings. You would not necessarily want to rush to pay off that mortgage or student loan since these have relatively low interest rates and can provide some tax advantages over time. (If you spend all of your time trying to pay off these good forms of debt, you may come to retirement with little to no savings to show for it.)

In order to keep things organized, you should begin by listing those high interest debts and prioritizing them according to factors like the interest rate or payments so you have an idea about which ones you want to wipe out first. Bear in mind that these priorities should not be set in stone, but keep open to readjustments based on current circumstances and the state of your savings and investments.

Keep your goals clear: You need to start by paying off the high-interest debts before you seriously tackled savings of any kind. Once it is out of the way, you can put a concerted effort at building up your savings amounts and finding sound investment opportunities. For those who have assets like 401(k) plans, savings, or even an IRA should think about liquidating those to eliminate the crippling effects of their high-interest loan or credit card debts. If this is too extreme, you could get a loan from your 401(k) to pay off the encumbering debt.

As far as the good debt is concerned, don't be overly concerned about paying that mortgage off immediately if retirement is decades away. There are some benefits available through the government such as getting a percentage of the interest payment back in the tax refund. If you have student loans, you could benefit from the changing conditions relating to interest even to the point where you may be able to right off all of your interest and take as long as you want to pay back the loans. There are other options in development to ease the burden of this type of debt.

It really does pay to have a plan so that you not only pay off the debt that is hindering your financial freedom, but also have the ability to set aside savings and make investments that will benefit you in the end beyond the shadow of debt!
About the Author
Peter Kenny is a writer for The Thrifty Scot, please visit us at Compare Loans and Credit Cards
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