Should You Pay Off Debt or Start Saving? Ask Yourself These Questions

If you’re anything like the average American, you probably carry at least some debt. The 2024 Northwestern Mutual Planning & Progress Study found that for people who carry personal debt, an average of 29 percent of their monthly income goes toward paying it off.

“When it comes to debt, it’s important to prioritize your net worth and follow the math, not emotions,” said Christian Mitchell, chief customer officer at Northwestern Mutual. “The stress of debt can be significant, and many feel an urgency to pay down these debts as quickly as possible. If you suddenly have a lump sum of money, it’s smart to pause and consider how to use it.” 

Focusing solely on paying off your debt (whether it’s credit card, automobile financing or student loans) can put you behind when it comes to saving and building wealth for yourself and future generations. The good news is that it’s entirely possible to work toward both goals at the same time. Here are some questions to consider that may help you clarify your financial priorities.

1. What are the interest rates on your debts?

Knowing the interest rates on your different debts will help you prioritize your goals because it gives you a clear understanding of how expensive your debt is—and which debts are good versus bad for your financial health. This is especially important when compared with the expected rate of return you hope to earn on your investments.

For example, if your debt carries an interest rate of 4 percent per year, but you reasonably expect your investments to earn 6 percent over time, then investing your extra cash might yield higher returns than if you used it to pay down debt. However, if your debt carries an interest rate of 20 percent, then it’s likely smarter to use the extra cash to pay down that debt.

This means that if you carry high-interest debt, such as credit card debt, payday loans, etc., using any extra money to pay down those debts will likely be a smart move.

2. What is your risk tolerance?

In investing, there are no guarantees; this means you have to have a certain amount of risk tolerance, which is the degree of loss you’re comfortable with having in your portfolio. Though the overall stock market has trended higher over time, any financial professional will tell you that past performance is not indicative of future results.

So if you are particularly risk-averse, paying off your debt might be more attractive to you simply because it is not subject to market volatility.

3. How much is your total debt?

If you are carrying too much debt relative to your income, servicing that debt may make living an enjoyable life difficult. If you think you may be in that situation, you may want to do some math to figure out your debt load and your debt-to-income ratio.

Then, see how your numbers stack up in the 28/36 rule: Are you spending no more than 28 percent of your pretax income on housing expenses (including any mortgage payments) and no more than 36 percent of your pretax income on servicing your total debt?

Next, figure out your credit utilization rate. This is an important factor in determining your credit score, as it measures how much of your available credit you are actually using. A rate below 30 percent is advised though even lower is better.

If you carry more debt than is recommended by either of these rules, it might make more sense to prioritize debt payoff over saving—at least until you get closer to the recommended amounts.

4. How stable is your career?

If you’re not concerned about losing your job, then you might be comfortable carrying a larger debt load because you’re confident in your ability to continue making payments over time. Depending on your answers to the questions above, you may prioritize saving over debt repayment.

But if you work in an industry or at a company that is undergoing some turmoil or, worse, contraction, you might face the risk of losing your job, hindering your ability to repay your debt. In this case, paying down your debt instead of saving could help you reduce your liabilities and give you greater peace of mind.

5. Are you hurting your financial future by not saving for it?

When you’re thinking about saving for the future, retirement is likely top of mind. If you’re eligible to contribute to an employer-sponsored retirement account, like a 401(k) or 403(b), it’s important to know whether you’re eligible to receive any form of employer match—and make sure you’re contributing at least enough to your retirement savings to claim that match.

If you have kids, thinking about the future probably also includes saving for college. And in the Northwestern Mutual’s 2024 Planning & Progress Study, nearly all of the respondents who are currently saving for college said they'd like to pay for the majority of their kid's college education.

So, while paying down your debt is certainly an important goal but think of it as one component to establishing your family’s present—and future—financial security.

Define your priorities

How you choose to prioritize paying down your debts and invest in your future will come down to your personal financial goals and priorities. Your Northwestern Mutual financial advisor can help you see how your debt fits into your larger financial picture and help you strategically balance paying down your debt, while you save for other future goals as well.

Information is provided for educational purposes only and is not a recommendation for any particular investment. All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss.