At some point in dealing with your finances and managing your money, you will probably ask yourself whether it is best to pay off your debts or save your money.
The straightforward answer to this is to get rid of your debt as soon as possible before you start to save. Read on to find out why.
Why You Should Pay Off Your Debts First.
The simple answer is that it costs you more to borrow money than the earnings you will get from your savings. There is interest charged on the amount you borrow, and this interest rate is higher than the rate you will receive on your savings.
Here is an example. Say you have £1,000 in a savings account earning 2% interest, the amount you would earn on those savings is £20. However, if you have £1,000 of debt on a credit card with an APR of 15%, the amount you would be charged is £150. So, that £1,000 would serve you much better paying off your credit card bill.
We are encouraged to save from an early age, and saving is a great habit. However, getting out of debt is an even better one, as it is much more costly than what you earn on your savings. So, clear your debts first, then continue with your savings.
As you clear down your debts, do it in a deliberate fashion, starting with the most expensive loan obligations. Generally, credit card debts are the ones with the highest interest payments. Get these debts cleared off first, then move on to the next expensive ones.
What Are The Exceptions To This Rule?
Of course, as with anything, there are exceptional circumstances when paying off your debts first is not practical or possible.
Quite often, debts such as mortgages come with early repayment charges. Such charges can amount to several thousands of pounds, which makes paying them off less beneficial than not. The only potential situation that would make paying these charges the sensible thing to do would be if you had a savings account interest rate high enough to cover the charge. The chances of this are, to put it bluntly, zero. So, for mortgage debt with early repayment charges, avoid paying this off first. Maintain your mortgage payment schedule, and when you come to renegotiate your mortgage, consider finding one with no early repayment charges.
Another situation where it does not make sense to pay off your debt is in the case of a student loan. With student loans, the interest rates are kept in line with inflation. Also, depending on your income, you might not have to pay it off, and eventually, student loan debt will get written off.
The next situation you might not want to pay off your debt is if you have secured a good deal on the interest rate. For instance, some lenders offer 0% interest rates for a limited period to entice new borrowers. If you are disciplined enough to pay off your debt during this period, it makes no sense to pay early. However, be careful not to let your debt extend to the period beyond the 0% interest. You will suddenly find yourself in a much different situation, facing hefty interest rates of around 18% or more.
Is It Still A Good Idea To Save?
Savers have not done too well in recent years in terms of getting a decent return on their savings. Still, every pound put away gives you a reserve that can be used in an emergency, or even for the odd luxury now and again. However, if your debt is costing you more than your savings are earning, you must get rid of that first, and then concentrate on saving.
As a general rule, save when you are able to make all regular mortgage repayments, you are clearing your credit card bill every month, and you have no other loans or outstanding credit.
Do the maths, and you will see. Trying to save while you have other debt will cost you more, and the debt will remain. Clear your debt first, then enjoy seeing your savings grow.