For many households, it's a personal finance dilemma: Should they try to pay down debt first, or build up savings? In the aftermath of the Great Recession, opinions have clearly tipped toward the ditch-your-debt side.

According to the August poll by the National Foundation for Credit Counseling, Americans are choosing to deal with what they owe: 89% of those surveyed said they value paying down debt over saving money; just 11% chose saving first.

America has a new aversion to debt, and with a national revolving debt tab of $798 billion as of June, and household debt averaging around $11,000, who can blame us? According to the NFCC, new purchases are more likely to be paid for with debit cards than credit.

A Question of Opportunity Cost

At face value, paying down debt sounds like it's always a good thing, but if it comes at the expense of saving, it's a bit more complicated.

"It is a good idea to pay down debt over savings if you have already started a savings account," says Harrine Freeman, author of How to Get Out of Debt: Get an "A" Credit Rating for Free.

If you had an extra $100 a month, what would you do with it?
Pay down debt.16073 (40.6%)
Put it in an emergency fund.9024 (22.8%)
Spend it.1942 (4.9%)
Give it to charity.292 (0.7%)
Save for retirement.4314 (10.9%)
I have no extra money, and don't think I will any time soon.7908 (20.0%)
Making your debt demon the top priority also makes sense if you are someone who loses sleep over debt, if you're trying to reshape your debt ratios and credit scores, or if you will benefit more from better cash flow later than today, says Rich Arzaga, founder of Cornerstone Wealth Management.

Then too, the value of paying down debt is directly proportional to the interest charged, says certified financial planner Michael Kresh.

Credit card debt, which can often exceed 20% interest, should always be a priority to pay down, he says. But all questions regarding how you allocate your money should be looked at through the lens of opportunity cost.

For example, is the interest you're paying on money you owe greater or less than the return on an alternative investment you could make with the funds?

If you have credit card debt at 14%, paying it off is like earning 14% on those funds -- a better profit than you are likely to make leaving the money elsewhere. And if the money you'd use is sitting in a low-interest bank account, you net much more by paying off that plastic. On the other hand, if you can refinance your mortgage to 3.5% - 4% (the lowest rates in our lifetimes), keeping a low-interest loan active while putting money into other investments can garner you a net profit, says Kresh.

Paying down debt also might not be the best move if you're likely squander the cash surplus once the debt is paid; if you're getting the benefit of an interest write-off to help offset your income taxes; or if you have the ability to manage debt in the short term or long term, says Arzaga.

Advocating for Saving

Not everyone agrees on the question of putting debt first.

To pay off debt before you have an emergency fund in place makes no sense, says Kevin Lynch, an assistant professor at The American College. Getting a cash cushion in place should be the first order of business, he feels.

Generally, people should be saving 10% of their income, says Thomas Fox, community outreach director at Cambridge Credit Counseling. "Although with the recession people began to save again, and it's now around 5% of income, in countries like Japan, the savings rate is 25%, and it's 50% in China."

In this uncertain economy, you should be looking to have money to cover at least 10 months of expenses where you can readily put your hands on it, says Fox.

If you do choose to focus on debt, don't get too relaxed once it's paid off. Instead, reallocate the amount you had been spending each month on freeing yourself from debt toward another major financial goal, such as retirement, education, buying a new car, or whatever tops your list.

In the best of worlds, we would split the difference: "Pay down debt and contribute to a savings account at the same time," says Freeman. "That way you will have an emergency fund and pay down debt which increases your credit score, reduces credit card usage and improves your financial life."


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254 Comments

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Courtney

Savings are definitely important, but if you are in heavy debt and it just keeps getting worse, it's important to make paying that debt a priority--it will only get worse if you don't. Some debt management plans even incorporate a special debt savings account so that you can prioritize the money you're giving to your debt, and the money you're giving to everything else in your life. Resource: http://www.fcsdebt.com/

September 19 2011 at 12:24 PM Report abuse rate up rate down Reply
Fred Thompson

Learn to live life WITHOUT CREDIT CARDS!! Its all a BIG LIE anyhow. Capitol is KING!! SAVE and learn how to live with out EXENTRICITYS!!! Forget marrige' forget having stupid kids ' to hell with owning a "home"! GET THAT **** OUT OF YOUR LIFE!!

September 14 2011 at 10:00 AM Report abuse rate up rate down Reply
Kapil

Paying down debt is of utter importance as the interest expense will keep on reducing once the debt burden comes down and that money can then be used for saving. And this decision depends on the interest rate of saving and debt.
I follow the predictions of http://www.forecastfortomorrow.com/ for investment. They are very accurate in all the predictions

September 10 2011 at 11:39 AM Report abuse rate up rate down Reply
Sandy Stipp

I'm doing both. Thankfully I have a high paying job that allows me to put money is the savings account every month and still have money to pay down on the credit cards. I should be credit card free within the next several months. I am God blessed.

September 08 2011 at 3:23 PM Report abuse rate up rate down Reply
zinkj0114

Clearly, the most important thing is to save the money. For most of your debts, which may or may not reflect bad decision-making, you can pretty much count on the government to bail you out at some point in the future. This is especially true if you are a big big company, even more if you are "too big to fail". So I recommend that you save the money; the consequences of your bad decisions can be spread across the entire tax base, and put off into the future.

September 07 2011 at 8:17 PM Report abuse rate up rate down Reply
Joseph Paretta

Paying down debts, especially credit card debt, is more important. By doing so, you are saving 18, 20, 22% interest. You can't find that kind of interest rate on savings vehicles.

Joe Paretta
Author - "Master The Card: Say Goodbye to Credit Card Debt...Forever!"

www.joeparetta.com

September 07 2011 at 4:54 PM Report abuse +1 rate up rate down Reply
vetxcl

Trick question. Both are important.
Can't have good credit without paying off or at least down debt. Never only pay interest on debt. There will always be something going wrong/unscheduled, so therefor having savings is a necessity

September 07 2011 at 2:26 PM Report abuse rate up rate down Reply
Wanda

You do need a small emergency fund before you attempt to pay debt ($500 to $1000) but then you need to pay down debt before doing any long-term savings. If your car craps out while you're paying off c/card debt, you'll feel better about paying for it with cash than about adding to your c/card debt.

Dave Ramsey's been saying this stuff for years. More people need to start listening to him!

September 07 2011 at 12:20 PM Report abuse rate up rate down Reply
jhaney143

"To pay off debt before you have an emergency fund in place makes no sense, says Kevin Lynch, an assistant professor at The American College. Getting a cash cushion in place should be the first order of business, he feels."

He makes no sense to me. Most high interest debt is in the form of a credit card so paying it off not only saves you money in interest but it is the same as creating an emergency fund since you have access to the credit should you need it later for an emergency.

September 07 2011 at 9:42 AM Report abuse +1 rate up rate down Reply
1 reply to jhaney143's comment
Jim

"To pay off debt before you have an emergency fund in place makes no sense, says Kevin Lynch, an assistant professor at The American College." - yeah, that is just what they want you to do to keep you in debt longer and get more money from you. Pay off your debt!

September 07 2011 at 11:22 AM Report abuse +1 rate up rate down Reply
James

It’s a personal thing. Some people worry more about debt than others, it may even be generational. In principle, I think it’s sensible to reduce debt but try to save something while doing it, even 15 or 20 a month. You will get a kick from watching it grow while your debts decline, and one bright day the savings will actually be greater than the debt.

September 07 2011 at 7:08 AM Report abuse rate up rate down Reply