Should you pay down debt or save?

Pay yourself first - it’s the cardinal rule of financial planning. Every month, you should be squirreling a chunk of your earnings away into savings. But what happens if you’ve got debt? It’s something most of us have according to recent statistics: Canada’s household debt hit a record high of $1.4 trillion last year - a whopping $41,740 for each and every Canadian. While your debt might be making you jittery, it doesn’t always mean you should panic and give up on your savings plan.

Stop first and ask yourself a few simple questions:

What kind of debt is it?
Believe it or not, you can actually have good debt. That is, money you are paying to own an asset that will rise in value over the years. Mortgage debt is a great example of good debt (when you can manage the payments of course). On the other end of the spectrum there’s the big daddy of debts to avoid: credit card debt. The interest rates are usually extremely high meaning card balances should be paid off in full every month.
Start by making a list of all the debt you’re carrying (mortgage, student loans, etc) and what interest rates you’re paying on them - those with the highest interest rates should be paid off first. Why save $2000 in a bank account for example, when you owe $3000 in a credit card with an 18 percent interest rate that’s sucking up your cash every month?

What are you saving for?
Saving for your retirement should be a priority - a registered retirement savings plan (RRSP) is a great way to do this. Your contributions are also tax deductible, which can generate a tax return you can use to invest more, save or pay down debt.

If you are building an emergency fund and using the savings for that instead of paying down debt, you might want to compare interest rates. So, if you have $5000 sitting in a bank savings account earning very little interest and you owe $5000 on a line of credit with an interest rate of 8%, then you might want to rethink your logic.
That being said, if you’re like me, a nest egg is a security blanket - money socked away in an account in case of an emergency. But if it’s costing you $400 a year to carry a balance on a line of credit, you have to decide whether it’s worth it to you.

Are you ready to wave goodbye to bad debt?
If you’re not able to pay off your credit card bills at the end of every month, then you’re racking up a lot more debt than you can handle - and it’s just going to keep on growing, even when and if you pay off the current balance. And those interest costs will eat into your monthly savings for a long time.
Set a budget and stick to it - that will help ensure that you don’t just build up more debt going forward.

Caroline Cakebread is a Toronto-based financial writer and editor. She’s also a recovering academic and the mother of two kids. Check out her personal finance blog for Chatelaine Your Money.