When you have extra money, should you pay down debt or save? An expert weighs in

By Jeanne Sahadi, CNN

(CNN) — Figuring out how to strategize paying down your debts while also saving for emergencies and big goals is a common dilemma for many.

Douglas Boneparth, a certified financial planner and founder of Bone Fide Wealth, tackles that quandary head on in this week’s Ask the Expert for CNN’s Savings Challenge. [If you have a question for Doug, please send it to savingschallenge@cnn.com. You can sign up for the weekly newsletter here.]

A reader from Vermont wrote: “School loans are debilitating. Do we consolidate or just keep making payments? When we have extra money, do we pay it toward school loans or save/invest it?”

DOUG: Great questions (and ones I hear a lot), because this situation is more common than people think.

On consolidation: Federal consolidation simplifies your payments, but it can extend your repayment term and cost you more in interest over time. It also can disqualify you from certain income-driven repayment plans or forgiveness programs. If instead you choose private refinancing – in which a private lender pays off your federal student loan balances and issues a new private loan in their place – that might lower your rate, but you’re permanently walking away from any federal student loan protections like deferment, forbearance, and forgiveness. So, you will want to know exactly what you’re giving up before you commit to anything.

Now, the pay-down-versus-invest-extra-money question. This one’s all about the math, and the math is pretty clear. Think of your loan’s interest rate like a guaranteed, risk-free return.

If your rate is above 6%, using your extra money to aggressively pay down your debt is compelling. That’s because paying it off sooner likely will save you more in interest payments than what you’d earn if you invest the extra money in the market, where it’s hard to consistently get a return over 6% without taking risk.

If, however, your rate is below 5% and you’ve got an emergency fund in place, investing the extra money (especially in tax-advantaged accounts) may serve you better over the long-term.

Here’s the framework I’d use when deciding how to deploy extra funds:

• Regardless of your loan’s interest rate, build a three-, six- or nine-month emergency fund first. No exceptions.
• Next, contribute enough to your workplace savings plan to capture any employer matching contributions, because that’s free money.
• If you’re all set on both those fronts, and your loan’s interest rate is above 6%, use your extra money to attack your debt aggressively. Rate below 5%? Consider investing it. If your rate is somewhere between 5% and 6%? Split it! Put some of your extra money toward loans and some toward savings or investment.

Have your own savings question for Doug? Please send it to savingschallenge@cnn.com. You can sign up for the weekly newsletter here.

Tip of the week: Want free, sound financial advice?

If you’re a woman, try Savvy Ladies, a nonprofit dedicated to empowering women to take control of their money. Their free helpline is staffed by financial professionals, and they provide free courses on specific financial questions.

If you or your spouse have a gambling addiction, GamFin offers one-on-one financial counseling, which is free in at least 17 states; as well as free virtual group sessions no matter where you live.

And if you want to learn how to manage your finances, join the five-day Get Good with Money Challenge, hosted online by Tiffany Aliche (aka The Budgetnista) every January.

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