Getting into debt is sometimes unavoidable for even those with the best-laid plans and can often mean paying for something for months, or even years, afterward. On the other hand, saving is a wise financial move that lets you earn interest. But should you be saving everything you can or paying off your debt as quickly as you can? The best move comes down to simple maths.
Which interest rate is better?
When weighing up whether you should pay off your debt or save your money, it is a good idea to have a look at a few things like interest rates and loan repayment times. Most credit cards and loan companies offer personal loans with an interest rate. That is, the money you loan earns interest per month until it is repaid. Which means you end up paying back more than what you originally loaned. i.e., the foundation of banking.
With savings, these accounts also have interest, but these accounts pay you interest in saving your money with the respective company. The problem with these two options is that savings accounts offer an interest rate that is more often than not lower than the interest rate for personal loan companies and credit cards. This can mean that the interest you’ll be paying back will cost you more than the interest you will earn on a savings account.
Another aspect to look at is the time over which you’ll have to pay back the personal loan and weigh that up against the same amount of time you would have your savings account for. You can then work out which will cost you more for the same amount of time.
Avoiding penalties
Nine times out of ten you will want to settle your debts when you can; it will cost you more to eventually pay back the personal loan debt compared to what a savings account interest would earn, however…
There are a few exceptions to the rule. In some cases, being locked in debt can mean penalties occur when too much is paid back. In this instance, it is financially better to save enough until you can pay back your personal loan without paying a huge penalty fee. It can also be financially better to pay off your most expensive debts first as those usually have a higher interest rate and will, therefore, cost you more in the long run. We recommend this guide on debt management to help you tackle yours in the most efficient way.
Although some people may believe that having an emergency fund is crucial, having a large amount of outstanding debt can be detrimental to your credit record and financial future. There is no point in having a large amount of debt with a large interest rate when you have a decent portion of savings tucked away that could essentially eliminate a good amount of that large amount of debt.
The time you used to save that decent portion, is the same time that increased your debt amount due to interest rates. Every day that you delay paying off your debt adds more money to that debt amount.
We’ve laid out some of the pros and cons behind each option below for convenience:
Paying off debt first – PROS
- The faster you pay debt off, the less interest you pay.
- Paying off your debt quicker improves your credit rating.
- The peace of mind that comes from knowing your debt is paid off is freeing.
- Prioritizing which debts need to be paid first means lowering your overall amount owed due to the highest interest rate accruing your more money to pay back.
Paying off debt first – CONS
- Putting your savings into your debt means not having an emergency fund.
- Paying off your debt first when the interest rate is low can be unhelpful, especially if a low-interest rate for your personal loan is on par with that of your savings account.”
Saving first – PROS
- If the interest rate of your savings account is greater than your credit card, you’ll be saving more
- Saving means having an emergency fund and lowering the risk of replacing old debt with new debt if you use your credit card in an emergency.
Saving first – CONS
- Most interest rates for personal loans or credit cards are higher than savings accounts which means you’ll be saving less than what you’ll be paying back.
- Saving first means consistently having a debt to pay off whilst knowing you have enough money to essentially pay off your debt.
Whichever option you go for, it’s a wise decision to have a look at all your options and make a decision from there. Take interest rates and repayment times into account and work out how much you would be paying back and how much you would be saving and decide what the best option for your budget is. If you’re really unsure, make sure to ask a professional for expert advice.