Should You Pay Down Debt or Save During COVID-19?
- Paying Debt or Saving?
The United States economy has suffered these past few months due to COVID-19 shutdowns and high unemployment. Analysts from the National Bureau of Economic Research say the U.S. is now in a recession. Everywhere, people are deeply concerned about their financial situations.
As the U.S. enters its fifth month of the coronavirus, you may be wondering what your best financial move is and whether you should save money or pay off debt. While you don’t want to make any huge decisions regarding your money, you do need to ensure you’re protected should the economy get worse.
Even if you were working on paying down your debt before the pandemic hit, now is the time to focus on saving money instead.
Why Save Money Now?
When asking yourself, "Is it better to save or pay off debt?" you need to look at the reality of the economic situation. Whether you are unemployed or have a job, there is still a possibility you could lose your income because of the coronavirus's ongoing effects.
According to economic forecaster Lakshman Achuthan, this recession will end up being much deeper than the last big financial crisis, the 2007–2009 recession. And during a recession, it’s best to save your money, since you never know what’s around the corner.
Even though many Americans are receiving enhanced unemployment benefits in the amount of an extra $600 a week, that program is scheduled to end in July, according to the U.S. Department of Labor. While a second stimulus check may be on the way, the government has not yet figured out how and when it will be paid out, so you need to rely on your own savings instead.
You need money not only for housing, utilities, health care and other necessities but also for emergencies. For instance, what if you were to contract COVID-19 and couldn't work for several weeks or longer? What if you had to take care of a loved one? What if your partner lost their job?
During regular economic times, only 61% of Americans report that they have the means to cover a $400 emergency with cash, savings or credit card, according to the Federal Reserve Board. While you could use a credit card for an emergency, using cash or savings is always better, because you’ll avoid interest.
Many financial experts, including Dave Ramsey, say that when it comes to deciding whether to save first or pay off debt, you should always save enough for an emergency fund first. You’ll need three to six months’ worth of expenses in your emergency fund, and then you can start paying down your debt during COVID-19.
Save Money, Pay Off Debt or Invest: A Comparison
Whether you save, invest or pay off debt will depend a lot on your personal situation. It helps to look at a comparison of all three scenarios to determine where you want to send your money, but remember the importance of building an emergency fund and tackling your debt. Then, you can start building your wealth by investing your money and watching it grow through the magic of compound interest.
Let’s say you take your savings and put it into an interest-bearing account. The interest you earn might look something like this:
Your 10-year interest earnings of only $2,661.49 on $20,000 don't sound like much, and it’s even more underwhelming if you park $10,000 in savings.
But imagine if you took those same lump sums of $10,000 and $20,000 and invested the funds.
As an alternative, consider how much money you’d spend in interest if you paid $20,000 worth of debt with a 16.2% interest rate over 10 years or even $10,000 at 10% interest over the same amount of time.
Assuming you have an emergency fund already set aside, in non-COVID-19 times, you may want to pay off your high-interest credit first. That’s because it’ll likely gain interest at a much higher rate than a savings account. Just looking at the numbers, in the save first or pay off debt argument, once you’ve got an emergency fund established, you should pay off the high-interest debt and then start adding to an investment account. A savings account might be a good place to park your emergency savings, but beyond that, there are better places to put your money.
Finding Debt Relief During COVID-19
Though you should focus on saving money first during the pandemic, once you get together that three- to six-month emergency fund, you can then focus on your debt. If your debt-to-income ratio is high, where a large portion of your income goes towards your debt, you'll need to make it a secondary goal to pay off your debt as quickly as possible to avoid interest charges.
Your short-term goal should be to ensure you are safe in case you lose your income, and you can go back to your long-term goal of paying off your debt once you have that crucial financial stability. Thankfully, the government and lenders have stepped up to help out with debt relief.
If you borrowed federal student loans to pay for your education, there is currently a six-month suspension on payments that lasts until September 30, 2020. If you borrowed from a private company, you may want to check to see if they are running any programs that would allow you to delay payments for a specified period. For instance, Sallie Mae is suspending loan payments for up to three months, and it won't affect your credit standing, according to Campus Federal.
If you are worried about paying back rent due to your landlord, you can always speak to your landlord about working out a payment plan. Some states have set up rent moratoriums, where renters can't get evicted for a certain period if they can't pay rent due to COVID-19.
In terms of your mortgage payment, if you have a federally backed mortgage and can’t pay it because of coronavirus, you can request forbearance for up to 180 days, according to the Consumer Financial Protection Bureau.
Credit Cards and Loans
If you have high-interest credit card debt, you can contact your credit card companies to see if they can reduce your payment or allow you to make late payments. For instance, Capital One is deferring payments and waiving fees for some cardholders during this time. You can also look into moving your balance onto a low-interest credit card.
If your credit score has gone up recently, you can also request to refinance your loans to see if you can snag a lower interest rate. That could help you pay back your debt faster as well.
Making the Best Decision for Yourself
While you don't know what lies ahead, what you do know is rather than buying a big-ticket item or going further into debt during this time, you should either save money or pay off debt. Once you feel secure with your three to six months' worth of savings, you can get back to your tried and true habit of paying your debt down. Hopefully, in the meantime, the economy will get back on track, and you can feel financially stable once again.
About the Author
Kylie Ora Lobell is a writer for MoneyGeek and an editor, marketer and publicist. She has over 10 years of experience writing in the personal finance, legal and business space for publications and brands like Legal Management Magazine, LegalZoom, Forbes, EMC, IBM, Dell, Mastercard, Visa and NCR. Her bylines include The Washington Post, The Los Angeles Times, The Jewish Journal of Los Angeles, New York Magazine and Time Out NY/LA. Her website is KylieOraLobell.com.
- Campus Federal. “Sallie Mae Offers Assistance for Borrowers Affected by COVID-19.” Accessed June 24, 2020.
- Capital One. “A Message from Rich Fairbank.” Accessed June 24, 2020.
- CNBC. “Recession depth will be much worse than 2007-2009, economic forecaster Lakshman Achuthan warns.” Accessed June 24, 2020.
- Consumer Financial Protection Bureau. “Guide to coronavirus mortgage relief options.” Accessed June 24, 2020.
- Federal Reserve Board. "Federal Reserve Board Issues Report on the Economic Well-Being of U.S. Households.” Accessed July 2, 2020.
- Federal Student Aid. “Coronavirus and Forbearance Info for Students, Borrowers and Parents.” Accessed June 2, 2020.
- The National Bureau of Economic Research. “Determination of the February 2020 Peak in US Economic Activity.” Accessed June 24, 2020.
- U.S. Department of Labor. “Unemployment Insurance Relief During COVID-19 Outbreak.” Accessed July 2, 2020.