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It's best to avoid using savings to pay off debt. Depleting savings puts you at risk for going back into debt if you need to use credit cards or loans to cover bills during a period of unexpected unemployment or a medical emergency.
There are times when it's advisable to use some savings to pay down debt, such as when you've already amassed a solid emergency savings fund. Here's how to know when it's a good idea to tap into your reserves to get rid of debt for good—and when it's not.
The Case Against Using Savings to Pay Off Debt
If you're considering dipping into your savings to make a dent in your debt, first make sure you don't fall into the following categories. In these cases, it's advisable to continue paying the minimum required per month toward your debt while pursuing other financial goals.
- You don't yet have a fully funded emergency savings account. Your No. 1 money goal is to save enough in an emergency fund so that you can safely ride out life's inevitable financial troubles. For most people, that means saving at least three months' worth of expenses in an accessible savings account, such as a high-yield savings account. If you're a freelancer or work in a seasonal job, it's wise to save closer to six months' worth of expenses. Until you have that amount saved, focus on building your emergency fund rather than paying off debt. Continue to make minimum debt payments to keep your credit score strong.
- You have trouble paying your bills each month. If there are months when you struggle to make the minimum required payment toward debt, or it's a stretch to pay for housing or utilities, you're not ready to use savings to pay off debt. Getting rid of debt is a worthwhile long-term goal, but it's important to reduce expenses or earn more income initially in order to comfortably afford bills. At that point, you can direct extra money to emergency savings. Only after you've got enough in an emergency fund should you consider paying extra toward your debt.
- Your debt carries low interest rates. If your debt is at 0% APR or is otherwise lower than average, you're not currently accruing a massive amount of interest—and that means you can focus on other goals while making required monthly debt payments (on time, of course). For instance, if you have a federal student loan with an interest rate of 4.53%, that is quite a bit lower than credit card debt with an interest rate of 15%. You need not feel an undue amount of stress to pay off low-rate debt unless you have a healthy amount of savings and you're already working toward other milestones that matter to you, such as saving for a down payment, a child's college education or a car.
- You haven't started saving for long-term goals. Before tackling debt, it's also important to identify what you might want to save for aside from an emergency fund. Saving for retirement, in particular, is critical—especially because the earlier you start saving, the more money you'll have as a result of investment growth. Set up regular contributions to a retirement account before tackling most debt. You may also want to start a down payment fund or a 529 college savings account for a child. But if your debt has very high interest rates and it's cutting into your financial security, you may want to pay it down simultaneously while saving for a home or college. (Prioritizing emergency savings and retirement savings are non-negotiables, though.)
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How to Start Paying Off Debt Without Dipping Into Your Savings
It might sound impossible to pay off debt without using your savings. But to keep savings intact and reduce debt at the same time, you'll likely have to either boost your income or look for ways to trim spending. You can also use found money—like a tax refund, inheritance or bonus from work—to get a jump-start on debt repayment. When you have the money to bring your debt down, even if it's $20 or $50 more than the minimum payment at a time, here are a few ways to approach it:
- Debt snowball method: Using this strategy, you'll pay extra toward the smallest debt first. When that's paid off, you'll direct the minimum payment you had been making on that account to the next-smallest debt. For instance, say you have three credit cards with balances of $500, $1,000 and $5,000. You'll use extra funds to pay off the $500 balance first, then direct that account's $25 minimum monthly payment to the account with the $1,000 balance. This will help you feel a sense of accomplishment by getting rid of debts faster, though it won't result in the most possible interest savings.
- Debt avalanche method: By contrast, the debt avalanche strategy suggests paying off the debt with the highest interest rate first, no matter its balance. That means you'll experience immediate interest savings as your highest-rate debt dwindles. This can take longer than the debt snowball method, though, if—using our prior example—the $5,000 debt is also the one with the highest interest rate.
- Consider a debt consolidation loan: If you don't have a lot of extra money to put toward paying down debt but you want a lower overall interest rate, a debt consolidation loan can help you bundle multiple debts together into a single monthly payment. This strategy works best when you have good or excellent credit and can qualify for the lowest possible rates on a debt consolidation loan—which, ideally, will be lower than the average rate you were previously paying. Also keep an eye on any fees the loan comes with, which can affect how much you actually save over time.
- Look into a balance transfer credit card: Those with good or excellent credit scores can also consider a balance transfer credit card to help pay off debt. These cards typically charge an introductory 0% APR for a period of time if you transfer your credit card balances to a new issuer. At the end of the 0% period, your rate will climb, so it's important to take advantage of that interest-free time to pay off debt using extra money available. Keep in mind you'll also generally have to pay a balance transfer fee of 3% to 5% of the transferred balance.
- Work with a credit counseling organization: You're not alone if you're confused about how to pay down debt without using savings. A nonprofit credit counseling organization can help you identify paydown strategies specific to your financial situation, often within a free hour-long debt counseling conversation. Counselors might suggest you consider a debt management plan for credit card debt, which is best for those who are concerned they won't be able to manage their debt otherwise. With a debt management plan, you'll make one monthly payment to a credit counselor, who will negotiate with your creditors to lower your interest rate or potentially how much you owe. You'll pay an administrative fee, and you'll have to close your credit card accounts to participate. Closing accounts could have a negative effect on your credit scores, so consider this option carefully.
How to Reduce Spending to Pay Off Debt Quicker
The best way to avoid using savings to pay off debt is to find money in other ways, and it may be quicker to spend less than to focus on earning extra income. You can start by using behavioral strategies like paying with cash instead of credit for a stretch, putting a pause on online shopping or storing your credit cards somewhere out of reach. But beware that if you don't use your cards for an extended period, your issuer might close the account, potentially without warning you first.
You can also do an audit of the memberships you subscribe to, like streaming services, online fitness programs, newspapers and magazines and digital tools that charge you monthly. If you haven't used a service in, say, three months, cancel it and redirect that money to savings. Or you can start to plan meals weekly, which can help you shop for groceries more intentionally and avoid takeout or too-frequent restaurant visits. Limiting spending on big items like your housing and transportation often comes with the biggest benefit.
In general, making a budget—even if it's just a target amount that you plan to spend each month on general categories like entertainment—can be an effective money habit that leads to even more positive financial behaviors, like more carefully considering impulse purchases. Looking at your average spending over the course of a few months, which is an important early step in the budgeting process, can also give you an immediate idea of spending categories where you can cut back.
Be careful not to trim spending so much that you leave no room for fun or important personal hobbies, though. That can be a recipe for resentment toward your budget.
Paying Off Debt the Smart Way
It can be tempting to use as much of your savings as possible to get rid of debt that you're eager to be free from. But resist that temptation if you don't already have savings for emergencies, retirement and other milestones. Aim to pay off debt while working toward multiple goals, and you'll be in a better financial position for years to come.