Money Smarts Blog
Dilemma: Build up your savings? Pay off your loan faster?
Sep 8, 2021 || Amy Orr, VP of Marketing
Despite wishful thinking, I’ve accepted the fact that I’ll never be one of those people who find a lost Jackson Pollock painting in the garage that’s worth $15 million or win $22.8 million with a $7 lottery ticket. I’m thrilled when I find $10 in my coat pocket.
It may not be $15 million, or even $1,500, but what if you found yourself with an extra $50 each month? What would you do? Pay extra on your loan or build up your savings?
Common financial advice would recommend putting any extra money toward your debt, which would lower the total cost of interest and allow you to pay off the debt faster. But we all know how the real world works – just because it makes the most sense, doesn’t mean it’s the best choice.
Even my friends have mixed opinions about it. I did a quick Facebook poll and 57% said they’d pay extra on the loan, the other 43% would save it.
“Pay off the loan. The interest on the loan will cost you more money than any interest you’ll earn on your savings account.”
“Build up savings so if you need a new furnace or something, you don’t have to add on to the debt.”
“Get the loan paid as quickly as you can and then once it’s paid, put that money in savings.”
“It depends on the loan, honestly. If it was my student loans at a super low-interest rate, build up savings. If it’s an interest rate over 5% or so, pay extra. (I don’t actually do this, this is just what I think I SHOULD do.)”
Reality is, there is no right answer. It depends on where you are on your financial journey. Maybe the better question is to ask – do you have an emergency fund?
If your answer is no, it may be wise to use that extra $50 to build up your savings. In a perfect world, we’d all have 3-6 months’ salary tucked away for the unexpected. But until Publisher’s Clearing House shows up on your door step with a big check, you’re on your own. So, aim for $1,000 to start. Want to build up your emergency savings quicker? Check out our One Year $1,000 Savings Plan.
Already have an emergency fund? Awesome! Keep up the good work. As long as you’re making the minimum payment on your loans, consider adding that extra $50 to your credit card balance or loan with the highest interest rate. For an auto loan, mortgage or student loan, it won’t change your monthly payment, but it can reduce the amount of interest you’ll pay long term. If it’s a credit card balance, you could drastically reduce the time it takes to pay it off.
They say you can’t have your cake and eat it too, but I disagree in this situation. What if you could pay off your loan faster AND build up your savings? The best of both worlds, right? Consider splitting your $50 – half toward your loan, half toward your savings or emergency fund. It’ll take a little longer to pay off the loan (and you’ll be paying a little more in interest), and a little longer to hit your savings goal, but it can happen.
Whatever you decide, just do it. There’s no wrong answer, just three right ones. Any way you look at it, you’re coming out ahead.
Originally published in Pathfinder Magazine - Q2 2018.