Step 4: Pay off debt & set saving goals
Sam has a $1,000 starter emergency fund (step 1) and a budget that leaves $580 a month (step 2). Before investing, that money has two jobs: get rid of expensive debt, and turn wishes into concrete saving goals. This lesson shows the order — and the maths behind it.
1. Debt: know what each one costs you
Not all debt is equal. What matters is the interest rate. Here are Sam's three debts — their minimum payments are the $150 line in the budget:
2. Avalanche or snowball?
With the starter fund in place, Sam decides to put $400 extra a month toward debt (on top of the $150 of minimums) and the remaining $180 into the emergency fund. Pay the minimum on every debt, then send all the extra to one debt at a time. When it's gone, its payment rolls on to the next. The only question is the order:
🏔️ Avalanche
Highest rate first
Credit card (24%) → store card (18%) → student loan (5%). Mathematically the cheapest.
⛄ Snowball
Smallest balance first
Store card ($600) → credit card → student loan. Quick wins that keep you motivated.
| Sam's plan | First debt gone | Debt-free in | Total interest |
|---|---|---|---|
| Minimum payments only | Month 24 | ~16 years | ~$6,300 |
| Avalanche + $400/month | Month 6 (credit card) | 22 months | ~$690 |
| Snowball + $400/month | Month 2 (store card) | 22 months | ~$705 |
The big lesson is in the first row, not the last two: paying extra cuts the interest bill by almost 90%, whichever order you choose. Avalanche saves a little more money; snowball gives an early victory. If motivation is your problem, snowball is fine. If you're disciplined, avalanche.
3. Saving goals: turn wishes into monthly numbers
Once debts are gone, Sam's $550 of debt payments become free. Any goal becomes a simple division:
- Car deposit: $6,000 in 2 years → 6,000 ÷ 24 = $250 a month.
- Wedding: $9,000 in 18 months → $500 a month.
- Home deposit: $30,000 in 5 years → $500 a month, before any interest. The savings goal calculator adds the interest for you.
Money you need within ~5 years belongs in safe places (savings accounts, deposits, short-term government bonds). Money for 10+ years away — like retirement — can be invested in diversified funds (step 5), where compound interest does the heavy lifting (see funds & risk). And remember inflation: a goal five years away will cost more than today's price.
The order of priorities
- Pay every bill and every minimum payment on time. Late fees and a damaged credit score are the most expensive mistakes.
- Build a starter emergency fund (around one month of needs, or $1,000) — step 1.
- Take any employer pension match. If your employer adds money when you contribute, that's an instant 50–100% return.
- Pay off high-interest debt — credit cards, store cards, overdrafts, payday loans — with avalanche or snowball.
- Complete the emergency fund (3–6 months of needs).
- Save for medium-term goals and invest for the long term (step 5). Low-interest debt like Sam's 5% student loan can usually just be paid as scheduled.
Want to see how long a loan really takes? Try the loan calculator.
Show the answer
The card costs 22% while the savings earn only 3%, so keeping both loses about 19% a year on $3,000 — roughly $570. But paying it all off would leave just $1,000, under one month of needs. A sensible middle way: keep about $1,500 (one month of needs) as the cushion, use $2,500 to pay down the card today, then clear the last $500 from the budget over the next month or two — and rebuild the emergency fund to 3 months afterwards.