Saving Money Vs. Paying off Debt: Which Comes First?

You should tailor your financial strategy according to your individual circumstances and priorities. (Shutterstock)

Most people, at some point of time or another, are faced with the dilemma of whether they should save first or put off saving till their debt is paid off. Well, as common as this predicament is, there is no one-size-fits-all answer to it.

Looking at it from a purely mathematical perspective - you are going to lose money if the total return you earn on your savings and investments is lower than the combined interest you pay on your debt.

So, is this logic enough to help you decide what to tackle first - saving or debt repayment? Souqalmal.com finds out if there's more to it. 

When it makes sense to pay off debt first

If you owe high-interest debt, the ideal strategy would be to focus all your energy and resources into paying off this expensive debt first. The idea behind this is to put a stop on the interest drain, since with high interest rates you will be bleeding money. And the longer this debt lingers on, the more you will lose.

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This is especially true in case of credit card debt. With credit cardholders in the UAE subject to an average interest rate of close to 40 per cent (APR), those that stick to just paying off the minimum 5 per cent every month, are building debt at a very fast pace. If you too are stuck with such credit card debt, you must tap into your financial resources to bring your outstanding credit card balance to zero before you think about building your savings. 

When it makes sense to save money first

If you haven't yet saved up for financial emergencies, you must direct your attention towards setting up an emergency savings fund first. Many people often overlook the importance of having a substantial and readily accessible emergency fund. But it can be your knight in shining armor if you're ever caught off-guard owing to an unforeseen financial crisis.

With no savings to fall back on, an unexpected job loss or medical emergency will force you to borrow once again. You could end up getting stuck in a cycle of ever-multiplying credit card debt or worse, get lured into borrowing from illegal loan sharks. Therefore, it is best to keep paying the required minimum on your debt until you build an emergency fund that's at least three to six months worth of expenses.

There's another scenario where it makes sense to save first - if the majority of your debt has a low interest rate like a salary-transfer personal loan or car loan, and you have access to savings options that earn a higher interest rate. For example, let's say you have a personal loan in the UAE at an interest rate of 5 per cent, and you earn a tax-free 7 per cent on your non-resident term deposit with the bank in your home country - it would make perfect financial sense to save first. 

Striking a balance

Ultimately, it isn't an all-or-nothing decision - you can strike a balance between settling debt and saving money. It's always a good idea to work with a budget - you can systematically allocate your income towards paying off your debts and putting money in saving accounts, fixed deposits or other investments. You change this allocation based on which financial goal you want to achieve first. 

Keeping your long-term financial goals in sight

Be it saving for a down payment on your future home, building a retirement nest egg or setting up a college education fund for your kids, your money should always be working overtime towards meeting your ultimate financial goals.

Irrespective of what you decide to focus on first - debt repayment or saving money - your fundamental aim would be to have a financially secure future for you and your family. And as is the case in any other financial decision, one size doesn't fit all. You should tailor your financial strategy according to your individual circumstances and priorities.