What's the general principle behind choosing saving vs. paying off debt?
It has to do with return. I don't know if Canada has a matching feature on retirement accounts, but in the US many companies will match the first X% you put in. So for me, my first $5000 or so is matched 100%. I'll take that match over paying down any debt. Beyond that, of course it's a simple matter of rate of return. Why save in the bank at 2% when you owe at 10-18%?  One can make this as simple or convoluted as they like. My mortgage is a tax deduction so my 5% mortgage costs me 3.6%. I've continued to invest rather than pay the mortgage too early, as my retirement account is with pre-tax dollars. So $72 will put $100 in that account. Even in this last decade, bad as it was, I got more than 3.6% return. Debt creates risk.  Plain and simple.  Comparing interest rates of debt vs. possible investing.  To me, it is all meaningless.  When you are in debt, you options are limited.  If you are not in debt, you have more freedom. To me, it is a no brainer.  Become debt free ASAP. "Think of yourself as a business with two accounts, ""cash"" and ""net worth"". Your goal is to make money. ""Cash"" is what you need to meet your obligations. You need to pay your rent/mortgage, utilities, buy food, pay for transportation, service debt, etc. If you make $100 a month, and your obligations are $90, you're clearing $10. ""Net worth"" are assets that you own, including cash, retirement savings, investments, or even tangible goods like real property or items you collect with value. The ""pay off debt"" versus ""save money"" debate, in my opinion, is driven by two things, in this order: If you start saving too soon, you'll have a hard time getting by when your car suddenly needs a $500 repair or you need a new furnace. You need to improve your cash flow so that you actually have discretionary income. Pay off those credit cards, then start directing those old payments into savings and investments." Depends upon the debt cost. Assuming it is consumer debt or credit card debt, it is better to pay that off first, it is the best investment you can make. Let's say it is credit card debt. If you pay 18% interst and have for example a $1,000 amount. If you pay it off you save $180 in interest ($1,000 times 18%). You would have to earn 18% on 1,000 to generate $180  if it was in aninvestment. Here is a link discussing ways of reducing debt Once you have debt paid off you have the cashflow to begin building wealth. The key is in the cashflow.
"Wow, you guys get really cheap finance. here a mortage is 5.5 - 9% and car loans about 15 - 20%. Anyway back to the question. The rule is reduce the largest interest rate first (""the most expensive money""). For 0% loans, you should try to never pay it off, it's literally ""free money"" so just pay only the absolute minimum on 0% loans.  Pass it to your estate, and try to get your kids to do the same.  In fact if you have 11,000 and a $20,000 @ 0% loan and you have the option, you're better to put the 11,000 into a safe investment system that returns > 0% and just use the interest to pay off the $20k. The method of paying off the numerically smallest debt first, called ""snowballing"", is generally aimed at the general public, and for when you can't make much progress wekk to week.  Thus it is best to get the lowest hanging fruit that shows progress, than to try and have years worth of hard discipline just to make a tiny progress.  It's called snowballing, because after paying off that first debt, you keep your lifestyle the same and put the freed up money on as extra payments to the next target.  Generally this is only worth while if (1) you have poor discipline, (2) the interest gap isn't too disparate (eg 5% and 25%, it is far better to pay off the 25%, (3) you don't go out and immediately renew the lower debt.  Also as mentioned, snowballing is aimed at small regular payments.  You can do it with a lump sum, but honestly for a lump sum you can get better return taking it off the most expensive interest rate first (as the discipline issue doesn't apply). Another consideration is put it off the most renewable finance.  Paying off your car... so your car's paid off.  If you have an emergency, redrawing on that asset means a new loan.  But if you put it off the house (conditional on interest rates not being to dissimilar) it means you can often redraw some or all of the money if you have an emergency.  This can often be better than paying down the car, and then having to pay application fees to get a new unsecured loan.   Many modern banks actually use ""mortgage offsetting"" which allows them to do this - you can keep your lump sum in a standard (or even fixed term) and the value of it is deducted ""as if"" you'd paid it off your mortgage.  So you get the benefit without the commitment.  The bank is contracted for the length of the mortgage to a third party financier, so they really don't want you to change your end of the arrangement.  And there is the hope you might spend it to ;) giving them a few more dollars.  But this can be very helpful arragement, especially if you're financing stuff, because it keeps the mortgage costs down, but makes you look liquid for your investment borrowing." "Your main reason to not pay off your debts right now seems to be: Enjoy life while ""I am young"" and not miss opportunities to have fun? I think the good news is that having fun usually does not require spending a lot of money. I would propose that most of the times when we considered something fun it had more to do with who we were with than what we were actually doing. Of course there are many fun things that are expensive, but there are even more fun things that require little money at all. My suggestion to you would be to prioritize your debt in a responsible way such that you have a plan to pay it off quickly, but if something comes along that does require extra money, don't be afraid to make an adjustment. For example, you can try to put 2000€ towards your debt every month, but if some exciting adventure comes along that you really want to do and it costs 1000€ one month, you shouldn't feel like you absolutely must turn it down. That month you could put 1000€ towards debt and the other 1000€ towards the adventure. I wouldn't recommend taking an adventure every month, but I wouldn't always turn one down either. Besides, I think most of the time you can have lots of fun for free." "Debt cripples you, it weighs you down and keeps you from living your life the way you want.  Debt prevents you from accomplishing your goals, limits your ability to ""Do"" what you want, ""Have"" what you want, and ""Be"" who you want to be, it constricts your opportunities, and constrains your charity. As you said,  Graduated in May from school.  Student loans are coming due here in January.  Bought a new car recently. The added monthly expenses have me concerned that I am budgeting my money correctly. Awesome! Congratulations.  You need to develop a plan to repay the student loans.  Buying a (new) car before you have planned you budget may have been premature. I currently am spending around 45-50% of my monthly (net)income to cover all   my expenses and living. The left over is pretty discretionary, but things   like eating dinner outside the house and expenses that are abnormal would   come out of this.  My question is what percentage is a safe amount to be   committing to expenses on a monthly basis? Great!  Plan 40-50% for essentials, and decide to spend under 20-30% for lifestyle.  Be frugal here and you could allocate 30-40% for financial priorities. Budget - create a budget divided into three broad categories, control your spending and your life. Goals - a Goal is a dream with a plan. Organize your goals into specific items with timelines, and steps to progress to your goals. You should have three classes of goals, what you want to ""Have"", what you want to ""Do"", and who you want to ""Be""; Ask yourself, what is important to you. Then establish a timeline to achieve each goal.  You should place specific goals or steps into three time blocks, Near (under 3-6 months), medium (under 12 months), and Long (under 24 months).  It is ok to have longer term plans, but establish steps to get to those goals, and place those steps under one of these three timeframes. Example, Good advice I have heard includes keeping housing costs under 25%, keeping vehicle costs under 10%, and paying off debt quickly.  Some advise 10-20% for financial priorities, but I prefer 30-40%.  If you put 10% toward retirement (for now), save 10-20%, and pay 10-20% toward debt, you should make good progress on your student loans." I believe this argument is most often used when considering which debts to pay back first, or when there are other options available such as investment options, building up an emergency fund, or saving for a large purchase.  In that case, it's simply justifying making minimum payments and paying more over the life of the loan in exchange for larger liquidity in the present. Unfortunately, when it comes to choosing between which debts to pay (e.g. My mom pays more than the minimum on her car because she can't deduct auto loan interest, despite her mortgage carrying a higher interest rate), it's only beneficial if the tax savings offsets the interest savings difference. The formula for that is: tax bracket > (1 - (target loan interest rate / mortgage interest rate)) That said, most people don't think in the long term, either by natural shortsightedness, or by necessity (need to have an emergency fund). Incredible article, tons of data. Thank you!   It does answer the above posters question if you're willing to read through. It provides data with and without 'revolving debt'.  Side note; interesting to see how age and income trend. Debt increasing during the family-middle aged years, and during the peak income earning years.  I'd say you want these credit card debt lower overall and on average; but with the distribution it may be sustainable. "There are other good answers to the general point that the essence of what you're describing exists already, but I'd like to point out a separate flaw in your logic: Why add more complications so that ""should I call this principal or interest"" actually makes a difference? Why's the point (incentive) for this? The incentive is that using excess payments to credit payments due in the future rather than applying it to outstanding principal is more lucrative for the lender. Since it's more lucrative and there's no law against it most (all) lenders use it as the default setting." "Good debt is very close to an oxymoron.  People say student loans are ""good debt,"" but I beg to differ.  The very same ""good debt"" that allowed me to get an education is the very same ""bad debt"" that doesn't allow me to take chances in my career - meaning, I would prefer to have a 'steady' job over starting a business.  (That's my perogative, of course, but I am not willing to take that 'risk.' /endtangent @Harmanjd provided the two really good reason for using cash over borrowing.  We have a tendency in this culture to find reasons to borrow.  It is better for you to make a budget, based on what you want, and save up for it.  Make a ""dream list"" for what you want, then add up the costs for everything.  If that number makes your head hurt, start paring down on things you 'want.'  Maybe you install just a wine cooler instead of a wine cooler and a beer tap, or vice-versa.  And besides, if something comes up - you can always stop saving money for this project and deal with whatever came up and then resume saving when you're done. Or in the case of the kitchen, maybe you do it in stages: cabinets one year, countertops the next, flooring the year after that, and then the appliances last.  You don't have to do it all at once. As someone who is working toward debt freedom, it feels nice whenever we have one less payment to budget for every month.  Don't burden yourself to impress other people.  Take your time, get bids for the things you can't (or won't) do yourself, and then make a decision that's best for your money." Liquidity Say you have $50k in student loan debt.  You come into a large amount of money and throw $10k at it.  Yes, it's now down to $40k, saving you a lot of money in interest over the long run, but it's money you can no longer 'use'. Now if you invest that same $10k instead, you still potentially have access to it if needed. Paying $10k towards a debt at a 5% interest rate has essentially the same rate of return as investing the $10k at a 5% return.  You're 'making' the same amount of money either way.  But if you say, get laid off or need money for medical expenses or a down payment on a house, you can tap into that $10k investment if needed.  It is a liquid asset. You would have to do the specific math with your specific situation to be certain, but - generally speaking it would be smarter to use extra money to pay down the principle faster on the original loan. Your ability to refinance in the future at a more favorable rate is an unknowable uncertainty, subject to a number of conditions (only some of which you can control). But what is almost always a complete certainty is that paying off a debt is, on net, better than putting the same money into a low-yield savings account. "If one takes a slightly more expansive view of the word ""saving"" to include most forms of durable asset accumulation, I think the reason some do and most don't is a matter of a few factors, I will include the three that seem obvious to me: Education Most schools in the US where I live do not offer personal finance courses, and even when they do, there is no opportunity for a student to practice good financial habits in that classroom setting. I think a simple assignment that required students to track every penny that they spend over the period of a few months would help them open their eyes to how much money is spent on trivial things that they don't need. Perhaps this would be more effective in a university setting where the students are usually away from home and therefore more responsible for the spending that occurs on their own behalf. Beyond simple education about personal finances, most people have no clue how the various financial markets work. If they understood, they would not allow inflation to eat away at their savings, but that's a separate topic from why people do not save. Culture Since much of the education above isn't happening, children get their primary financial education from their parents. This means that those who are wealthy teach their children how to be wealthy, and those who are poor pass on their habits to children who often also end up poor. Erroneous ideas about consumption vs. investment and its economic effects also causes some bad policy encouraging people to live beyond their means and use credit unwisely, but if you live in a country where the average person expects to eat out regularly and trade in their automobiles as soon as they experienced their highest rate of depreciation, it can be hard to recognize bad financial behavior for what it is. Collective savings rates reflect a lot of individuals who are emulating each other's bad behavior. Discipline Even when someone is educated about finances, they may not establish good habits of budgeting regularly, tracking spending, and setting financial goals. For me, it helps to be married to someone who has similar financial goals, because we budget monthly and any major purchases (over $100 or so) must be agreed upon at the beginning of the month (with obvious exceptions for emergencies). This eliminates any impulsive spending, which is probably 90% of the battle for me. Some people do not need to account to someone else in order to spend wisely, but everyone should find a system that works for them and helps them to maintain some financial discipline." "All of the provided advice is great, but a slightly different viewpoint on debt is worth mentioning. Here are the areas that you should concentrate your efforts and the (rough) order you should proceed. Much of the following is predicated upon your having a situation where you need to get out of debt, and learn to better budget and control your spending. You may already have accomplished some of these steps, or you may prioritize differently. Many people advise prioritizing contributing to a 401(k) savings plan. But with the assumption that you need advise because you have debt trouble, you are probably paying absurd interest rates, and any savings you might have will be earning much lower rates than you are paying on consumer debt. If you are already contributing, continue the plan. But remember, you are looking for advice because your financial situation is in trouble, so you need to put out the fire (your present problem), and learn how to manage your money and plan for the future. Compose a budget, comprised of the following three areas (the exact percentages are fungible, fit them to your circumstances). Here is where planning can get fun, when you have freed yourself from debt, and you can make choices that resonate with your individual goals. Once you have ""put out the fire"" of debt, then you should do two things at the same time. As you pay off debt (and avoid further debt), you will find that saving for both independence and retirement become easier.  The average American household may have $8000+ credit card debt, and at 20-30%, the interest payments are $150-200/month, and the average car payment is nearly $500/month.  Eliminate debt and you will have $500-800/month that you can comfortably allocate towards retirement. But you also need to learn (educate yourself) how to invest your money to grow your money, and earn income from your savings. This is an area where many struggle, because we are taught to save, but we are not taught how to invest, choose investments wisely and carefully, and how to decide our goals.  Investing needs to be addressed separately, but you need to learn how. Live in an affordable house, and pay off your mortgage.  Consider that the payment on a mortgage on even a modest $200K house is over $1000/month. Combine saving the money you would have paid towards a mortgage payment with the money you would have paid towards credit card debt or a car loan. Saving becomes easy when you are freed from these large debts." "Good debt and ""Bad debt"" are just judgement calls.  Each person has their own opinion on when it is acceptable to borrow money for something, and when it is not.  For some, it is never acceptable to borrow money for something; they won't even borrow money to buy a house.  Others, of course, are in debt up to their eyeballs. All debt costs money in interest.  So when evaluating whether to borrow or not, you need to ask yourself, ""Is the benefit I am getting by borrowing this money worth the cost?"" Home ownership has a lot of advantages: For many, these advantages, coupled with the facts that home mortgages are available at extremely low interest rates and that home mortgage interest is tax-deductible (in the U.S.), make home mortgages ""worth it"" in the eyes of many. Contrast that with car ownership: For these reasons, there are many people who consider the idea of borrowing money to purchase a car a bad idea.  I have written an answer on another question which outlines a few reasons why it is better to pay cash for a car." "Debt is nominal, which means when inflation happens, the value of the money owed goes down.  This is great for the borrower and bad for the lender. ""Investing"" can mean a lot of different things.  Frequently it is used to describe buying common stock, which is an ownership claim on a company.  A company is not a nominally fixed asset, by which I mean if there was a bunch of inflation and nothing else happened (i.e., the inflation was not the cause or result of some other economic change) then the nominal value of the company will go up along with the prices of other things. Based on the above, I'd say you are incorrect to treat debt and investment returns the same way with respect to inflation.  When we say equity returns 9%, we mean it returns a real 7% plus 2% inflation or whatever.  If the rate of inflation increased to 10% and nothing else happened in the economy, the same equity would be expected to return 17%.  In fact, the company's (nominally fixed) debts would be worth less, increasing the real value of the company at the expense of their debt-holders. On the other hand, if we entered a period of high inflation, your debt liability would go way down and you would have benefited greatly from borrowing and investing at the same time.   If you are expecting inflation in the abstract sense, then borrowing and investing in common stock is a great idea. Inflation is frequently the result (or cause) of a period of economic trouble, so please be aware that the above makes sense if we treat inflation as the only thing that changed.  If inflation came about because OPEC makes oil crazy expensive, millennials just stop working, all of our factories got bombed to hades, or trade wars have shut down international commerce, then the value of stocks would most definitely be affected.  In that case it's not really ""inflation"" that affected the stock returns, though." As others mentioned, the only clear reason to remain in debt is if you can find an investment that yields more than what you're paying to maintain the debt. This can happen if a debt was established during low-rate period and you're in a high-rate period (not what is happening now.) A speculative reason to keep debt is as an inflation bet. If you believe money will shortly lose value, you are better off postponing repayment until the drop occurs. However you're not likely to be able to make these bets successfully. Hope this helps "Pay off the highest rate debt. Interest on both are charged on the balance owed, nothing more complicated than that. There are those who would call a mortgage ""front loaded"" but that's nonsense. Of course most of the payment is interest at the beginning because the debt is higher and you start with a 30 year term. The fastest way to pay off multiple debts is always from highest rate first and then the next and so on."