Deciding whether you should be saving for the future or paying off the debt you have is a question that most people struggle with.
The answer though will depend on your own situation and how much debt you have. Ideally, you’d like to be able to be completely debt-free but you don’t want to sacrifice your savings goals in the process. For most, it’s a balancing act between deciding what to spend on debt repayment and how much you can contribute to your savings.
First of all, how much debt do you have and what kind of debt?
The balancing act between saving and paying off debt has become even more difficult with interest rates going up. As a result, debt for something like a a line of credit is now more expensive to repay.
It’s important to find where you fit on the scale in order to do what’s right for you and your own financial situation.
The best way to assess your debt is to calculate your debt-to-income ratio. This tells you how much you owe compared to how much you earn.
Use our debt-to-income calculator here.
If you have “some debt,” your debt-to-income ratio is probably sitting between 0-30%. This is great!
Most people carry some level of debt, whether it’s from a credit card, student debt, or mortgage and car payments. In this case, you have debt but it’s easily manageable with the income you have. If this sounds like you, the best thing you can do is to both save and pay off debt. But because your debt is so manageable, you can concentrate more on your savings.
You have a lot more flexibility with what you can do with your money than most. You should certainly be putting money aside for your retirement. You can also choose to take a few risks with investing money in to increase your capital.
If you have children, it’s also a great time to save money towards their post-secondary education costs. It’s also a good idea to set money aside in an emergency fund to cover at least three months’ worth of expenses.
It’s important to remember that not all debt is bad. Something like a mortgage payment is an investment in your future. And make sure you have a healthy emergency fund to cover a few months of expenses in case of the unforeseen.
If you have “a lot of debt,” you most likely have a debt-to-income ratio between 30-40 percent.
This is where things can get a bit tricky. Obviously, you want to try and save for your future but you also want to reduce your debt burden.
There are a variety of options you can use to start reducing your debt in this scenario. The best thing you can do is pay down the debts that have the highest interest rates first.
Credit card debt is something you’ll want to target quickly. Credit card companies purposely make the minimum payment low as they make their money off interest payments, meaning it can take years for you to pay off the balance entirely if you only make the minimum payment and it’ll cost you more in the long run rather than if you just paid it off in full.
You should always be aiming to pay more than the minimum on all of your debts to minimize how much interest you’ll pay. If you’re focusing on paying one specific debt off though, make sure you are still making the minimum payments on the rest of your debts. You don’t want to fall behind and have it effect your credit score.
If you’re also able to pay off some of your smallest debts in full right away it can give you a huge motivational boost to tackle the larger debts, as well as remove those smaller debts from being on your mind anymore.
But still don’t forget about your savings!
Do your best to build your own emergency fund for unanticipated events as well. It might take a while to fully shore up this fund, but every little bit helps. Remember that it’s more about the habit of saving than how much you save.
There comes a point when it’s just impossible to continue to meet all your debt payments and that’s when you need professional help. If your DTI is 40% means that almost half of your monthly income is going towards repaying money. That’s not something you want to have happen.
Looking at your debts it’s also important to think about to how long it will take you to repay them on your own and if you can actually keep up for the duration of the payment period. Ask yourself if you can continue paying the debt down for an extended period of time without racking up more of it over time.
Are there so many debts that you can no longer keep track of them all? Are the minimum payments simply too high for you to be able to continue to meet all of them over the next year? Three years? Five years?
Is your debt stopping you doing what you want to do with your life?
If the answers to those questions have you realizing that it’s simply impossible for you to repay your debts on your own don’t worry, there is professional help available to help you get out from under it.
Beginning debt counselling with a BDO Licensed Insolvency Trustee (LIT) is the best way to start. They’ll not only evaluate your debt situation, but also advise you on your debt relief options to you get back on the right side of the balance sheet.
To discuss your financial situation please contact us for a free consultation.