Is it better to pay off debt or save?

It depends on one number — the interest rate on the debt compared to what the money would earn. A dollar that cancels 24% debt returns more than a dollar that earns 5% in a savings account. But a dollar that cancels 4% debt returns less. The arithmetic is the same in both cases; the rate decides the answer.

The rate test

Every extra dollar you send to a debt avoids the interest that dollar would have accrued. That avoided interest is a guaranteed return, at the debt’s rate, risk-free. If the debt charges more than the savings account pays, paying the debt is saving — at a higher rate. If it charges less, you keep more by letting the debt run and putting the cash where it earns more.

Two worked examples, same extra $200 a month

Both examples spend exactly $350 a month — the minimum plus the extra — and are measured over the same horizon: the month the debt is gone either way. What is compared is net worth, savings minus what is still owed. That protocol matters more than it sounds. A comparison that lets one side save for longer than the other measures the difference in effort and calls it a difference in rate.

Credit card at 24% — pay the debt

A $6,000 balance at 24%, minimum $150. Adding $200 a month:

• The card is gone in month 22 instead of month 82, and $4,770 of interest is never charged.
• At month 82, paying first leaves $24,160 of net worth. Saving first leaves $19,611 — the same money, spent the same way, in a different order.
• Paying the debt leaves you $4,549 better off.

Auto loan at 4% — save first

Same $6,000 balance, but at 4%, same minimum, same $200 a month:

• Paying it down early still avoids $262 of interest — the money is not wasted, it is simply working at 4% instead of 5%.
• At month 44, saving first leaves $9,786 against $9,714 for paying first.
• Saving leaves you $72 better off — and you have cash on hand the whole time. Note how small that is next to the card. One point of rate difference buys one point of advantage; it does not buy a decision worth agonising over.

The check that this comparison measures the rate and nothing else: set the debt rate and the savings rate to the same number, and the difference between the two strategies is exactly zero — not small, zero. A model that returns anything else at that point is measuring something other than what it claims, and ours is held to it by a test.

Three things the rate test does not see

• Emergency fund. If you have no savings at all, even expensive debt should wait until you have enough to cover one month of expenses. Without that buffer, any surprise sends you back into debt at a worse rate — and the arithmetic that said “pay debt first” assumed you would not borrow again.
• Employer match. An employer match is the largest guaranteed return most people will ever be offered: a dollar-for-dollar match doubles the money the day it vests, and even a half match returns 50% — more than any ordinary debt charges. Take the match before paying extra on an ordinary debt. The exception is debt that outruns it: a payday loan at a triple-digit annual rate beats any match, and comes first.
• Psychological weight. Carrying a balance costs attention, not just interest. If killing a small debt frees you to focus, the rate test understates the value of paying it off. The debt payoff calculator compares the two strategies — avalanche (lowest cost) and snowball (fastest closure) — on your own numbers.

Where this goes wrong

Your own numbers

The debt payoff calculator shows what extra payments save on your debts, and the savings calculator shows what the same money earns at a given rate. Run both with the same monthly amount, and the one that produces a larger number is the answer.