Whether to save or pay off debt

It’s one of the most common questions financial advisers hear — should I give priority to paying down debt or building up savings?

North Americans have a cosy relationship with debt — student loans, credit cards and car loans are commonplace. Then there’s mortgage or real estate-secured debt, such as homeequity lines. Add rising interest rates to that mix and you’ve got quite the budget burden.

Debt can help advance your life, for example by paying for an education to get a job or buying a car to get to work. But paying it back also uses up money that could be set aside for emergencies, retirement or other expenses.

Research shows most North Americans are ill-prepared to face a minor financial hiccup, let alone the cost of retirement.

So how do you meet these competing demands? We talked to a few financial experts for their tips.

ASSESS

First, take a good look at what you’re up against. How much debt do you have and at what interest rates? How much savings do you have? Other questions to consider, according to certified financial planner Alison Norris, include: Are you only making minimum payments? Are your finances a source of stress in your life?

Then, look at your budget — knowing how much money you have to work with will help you figure out what is feasible, said Charlie Bolognino, a certified financial planner based in Bentonville, Arkansas. The budget is the key to unlocking solutions.

“We hear we are supposed to do all these things with money — save it, spend it, invest it and get out of debt — but there’s only so much money to go around,” said Bolognino.

PLAN

Come up with a strategy you can stick with.

A successful plan will address both debt and savings in concert, to make the most of the money you do have.

It’s not about focusing on one issue then moving on to the next, but rather a matter of determining where your spending priority is, said Bruce McClary of the U.S. National Foundation for Credit Counseling.

A rule of thumb is to allocate 20 per cent of your take-home pay to savings and debt payments. How you divvy that up will depend on your priorities.

One thing the experts agree on is to make emergency savings a top priority. Don’t worry about getting several months of savings set aside. Even $500 can provide peace of mind. This allows you to handle life’s unexpected emergencies, such as a car repair or lost cellphone, without running up more debt.

Tackling your highest interest rate debt should be near the top, too. The average interest rate on credit cards is about 17 per cent, and more interest rate hikes are anticipated in the near future, according to McClary.

Compare that with the single-digit interest rate you might get from a standard savings account and it’s an easy decision.

“It’s the best time ever to not carry a balance,” McClary said.

Calculate how long it will take to pay off your debt, knowing that date will remind you there’s light at the end of the tunnel.

Then, think about your lowerinterest rate debt, such as student loans. While it may be tempting to turn your back on longer-term savings, don’t — that is just trading today’s financial ruin for another down the road.

Don’t overlook opportunities for workplace retirement savings accounts, particularly if your employer matches your contribution.

Failing to give at least the amount up to that level is like leaving money on the table, said Paul Golden of the U.S. National Endowment for Financial Education.

Some employers may have additional benefits to help with saving or paying down student loans.

If you find you simply cannot make minimum payments on your debts or have exhausted your financial options, try to get help through a non-profit credit counselling organization.

“There’s a point when you can’t go it alone anymore,” McClary said.