Should You Pay Off Debt or Save First? A Clear, 4‑Step Playbook

The 4‑step decision

• Start with a buffer: Build a starter emergency fund of 1–2 months of essential expenses to avoid new borrowing when surprises hit; then keep adding toward 3–6 months as debts fall.
• Capture free money: Contribute enough to get the full employer 401(k)/NPS match if offered; skipping it leaves “free return” on the table even while tackling debt.
• Eliminate high‑interest debt: Prioritize credit cards and personal loans above the expected long‑term return from investing; an empirical guideline favors paying down debt above about 6%6% APR first.
• Optimize the rest: With low‑rate debts (e.g., many student loans, mortgages), it often makes sense to keep paying on schedule while directing more to investing and larger emergency reserves.

Why the 6% threshold?

Analysis suggests that when expected portfolio returns and tax advantages are weighed, paying off debts above roughly 6%6% tends to beat investing unmatched dollars for many savers; below that, investing may produce better long‑run outcomes, especially for those far from retirement. Adjust this threshold up or down depending on risk tolerance and asset mix—more conservative portfolios justify a lower cutoff; aggressive portfolios can justify a higher one.

Practical tactics

• Automate both: Set autopay for debt minimums and automatic transfers for savings/investing to avoid decision fatigue and missed payments.
• Refinance and consolidate: If refinancing meaningfully lowers the APR, it can shift a debt from “pay off now” to “pay on schedule” while freeing cash flow.
• Use windfalls wisely: Apply bonuses/tax refunds first to high‑APR balances, then to emergency fund top‑ups or investment contributions.
• Protect credit: Avoid new hard inquiries and keep utilization under 10%10% during payoff to lower borrowing costs and insurance premiums.

Special cases

• No emergency savings: Prioritize saving a small buffer before heavy payoff to prevent a single expense from forcing new high‑APR borrowing.
• Student loans with employer 401(k) match: New rules let some employers match retirement for student loan payments—capture this benefit while paying loans.
• Psychological factors: If motivation is a hurdle, a short “snowball” sprint on the smallest debt can build momentum before switching to a math‑optimal avalanche.

FAQs

• How big should the emergency fund be? Start with 1–2 months quickly; grow to 3–6 months as debts fall, and to 6–12 months if income is volatile or self‑employed.
• Should investing ever come before debt payoff? Yes—capture employer match first, and for low‑APR loans below ~6%6%, long‑term investing can be preferable after securing a cash buffer.
• What if all debts are high‑interest? Pause extra investing beyond the match and focus on aggressive payoff until APRs are below the threshold.
• Is there a universal answer? No—the framework depends on APRs, job stability, match availability, time horizon, and risk tolerance; review the plan annually and after major life changes.