Let’s say you suddenly have an extra $5000 to “play” with. You need to make a decision. Should you put it towards paying off existing credit card debt? (Let’s say you have $8000 in credit card debt for example’s sake.) Should you put it into savings and earn a very modest, but relatively stable, amount in interest? Or should you invest it, potentially earning even more in interest?

In many cases when you really take a look at the cold, hard numbers your best option is to put the money towards your existing debt. Let’s talk about why, and what exceptions there might be.

It’s All About the Interest

There’s one big deciding factor when it comes to the debt vs investments / savings debate. And that factor is interest. Let’s say we have the following options:

1. Pay off credit card debt — you currently pay 19% in interest.
2. Put the money in a savings account — at 2% interest.
3. Invest your money — assume you can reasonably expect a 10% return on your chosen investment.

The highest interest rate is that of your credit card debt. Therefore your money would be best spent paying down that interest-gathering balance. On the surface it’s easy to assume anything letting you earn interest is better. But that isn’t true. If you earn 10% on that money, you’ll still be paying 19% on that same amount (because you didn’t pay it off) during that first year. That puts you 9% in the hole on that $5000. If you pay off that $5000, you won’t pay any further interest on that amount — only on your remaining balance.

Therefore you aren’t really “earning” anything at all. You’re just decreasing the amount you owe — but you could decrease it more by using the money to pay down the principal balance up front. Then, take your monthly payments that would otherwise go towards that portion of your debt, and save or invest that to start earning money.

Exceptions to the “Pay Debt Off First” Rule

Just because that example featured high interest credit card debt, it doesn’t mean that’s your own situation. If you have a very low interest rate like with the Citibank Clear Platinum credit card, and you can reasonably assume that an investment would offer a higher rate of return than you’re paying, then it makes more sense to put your money into that investment.

Where you put your money is a very personal decision. Just make sure you understand the numbers before making that decision, and you’ll be able to improve your financial situation even faster than you ever thought possible.