Save or Pay Off Debt First?

Again, most people aren't in the enviable position of having financial flexibility to spare. And what many want to know is: Should I hold off on my debt repayment plans until I get my emergency fund pulled together, or should I pay off my debts first?

The question of whether to save or repay is one that people with a little financial savvy love to debate. The save-firsters point out that the more cash on hand you have, the better you can survive an emergency without running up more debt.

The problem with that approach is that many people would be paying pretty high rates on their debt while they slowly put together their cash stash. And it usually doesn't make much sense to earn 2% or so on your savings when your debt is costing you 10%, 15%, 20%, or even more.

I'm of the school that urges people to pay off their credit card debts before they do anything else. Credit cards usually carry pretty high rates, and every dollar of credit card debt you pay off frees up a dollar of unused credit space on your cards that you can use if you face a real emergency. Unused credit on cards and a home equity line of credit can serve as a de facto emergency fund until you get around to saving for a real one.

The key, of course, is to stop using your cards while you're in debt repayment mode unless you're facing a real emergency. You can't crawl out of the hole you're in if you keep digging.

Paying down revolving debt like credit cards and lines of credit can have another beneficial effect: It can quickly boost your credit score, the three-digit number lenders use to help gauge your creditworthiness. Among other things, the credit-scoring formula measures the gap between the credit you're using and your available limits; the wider you can make that gap, the better. Paying down debt is a great way to strengthen your score and put you in a good position to get low rates the next time you need a loan.