As adults, we encounter multiple money problems as life goes on. We may have incurred hefty debts from our “yoloing” card swiping mania. Or life just hits us with emergencies that cycled into a monster debt.
So unless you are an heir to a million dollar fortune, we wonder. If you manage to scrape up extra money, should you save up or pay your debt first?
Assess Your Situation
Logically speaking, paying up interest-bearing debt should be the plan of action. But in real life, it’s not as simple as it seems. If you have only extra $1,000 and $10,000 in debt. Do you actually give up all the $1,000?
So the answer in this will depend on your current situation. How does your budget look like? Do you even have a budget in the first place? You need to check your budget to know how much money you are working on in a certain month.
Most likely, you would have an idea what to do after seeing this. If you don’t have a budget yet, you can try the Japanese Kakeibo Savings Method. Or if you have varying income as a freelancer, you can check this ultimate budgeting guide just for you.
After facing your debt monsters, you know now exactly how much you currently have, how much you are keeping per month, and how much you owe. Now it’s time to decide, save up or pay up?
When to Save Up?
After seeing your balances, you’ve realized, you don’t have any savings at all. This is dangerous. It’s important to have at least an emergency fund.
An emergency fund protects you from, well, emergencies that are unexpected. Things like a sudden sickness. A car repair. Getting laid-off. Anything out of the ordinary.
It is recommended to have at least three to six months of living expenses stashed up in case of emergencies. But if you really have a tight cash flow, you can save a month’s worth of emergency fund while you pay your minimum balances.
This will secure you for sudden mishaps, which usually turns to debt when you got no money. Having that one-month buffer will at least guard you against getting into credit card debt again.
When to Pay Up?
When you have high-interest consumer debt such as credit card debt, it’s better to prioritize them after building your emergency fund (for at least a month’s worth whilst on debt-paying mode). This will allow you to lower the amount of interest you are paying slowly. In the Philippines, it’s roughly 3% per month interest for credit cards. Imagine getting that in the stock market or savings account.
You can also opt to open a balance transfer card to significantly lower the interest and spread the amount owed for numerous months. Some banks in the Philippines allow you to transfer your balances with an interest of just 0.60% – 1% per month.
I suggest you do this but refrain from adding more consumer debt just because you have more credits available. Think about your goals and stop that hand from swiping!
Bonus: What If You Have Extra Cash and You Covered Your Debts Already?
First of all, I congratulate you on beating one of your greatest challenges yet. Some don’t even conquer this predicament in their lifetime. So Kudos to you.
The next step now is to save up your money and put it in investments. You have multiple options.
One is a PERA (Personal Equity Retirement Account) Account. It’s similar to the IRA. You can max your contributions for up to 100,000 PHP a month with tax exemptions and additional tax benefits such as a 5% tax credit. You can then use your tax credits when paying your income taxes or property taxes.
There are UITFs (Unit Investment Trust Funds) also for your extra savings.
If you are more adventurous, you can even try to learn about investing in the Stock and Forex markets. But you need to study how to do this because it’s risky for the inexperienced.
So with that, I hope you find your personal answers. Good luck!