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Should I Pay Off Debt Or Increase Savings?
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Its Great To Save - BUT...
We are always being told that we should be saving money and putting something aside for emergencies and so on, and we all feel more secure with a little bit in the bank. However, this is fine if you are relatively debt free, but when you have significant debts to pay off, you are wasting money by putting savings away at the same time.
The simple fact is that it will always cost you more money in interest for money you owe than you can ever get in interest on money you save. It has to - that is how banks work. They pay you a little bit for the money you deposit with them, so that they can lend your cash out to other people (or you!) at a higher rate. The difference between what they pay you and what they charge for borrowing it is their profit, and the basis of the whole system by which banks make money.
Should I Pay Off Debt or Increase My Savings:
Credit Card Debt v Savings
Imagine you had a debt of £2,000 on a credit card and someone then gave you £2,000 as a present. You might be reluctant to consider using it all to pay off your debt, because you would feel as if you were being left with nothing to show for this magnificent gift. You are more likely to want to put it in the bank, but that would be a mistake as it would cost you money if you did this. The cost to you of paying the interest on your credit card not only wipes out any interest you make on savings, but costs you a lot more besides.
The interest you are charged every month on your credit card debt is likely to be about four times the interest that you will get from putting the same amount of money in the bank. So every day you have an unpaid debt while you have savings in the bank is costing you money. Debt is a drain on your resources, so you have to aim to get rid of it as quickly as possible.
Should I Pay Off Debt or Increase My Savings:
Yes You Should...UNLESS...
The above guidance is an excellent rule of thumb, but as with most rules, there is the odd obvious exception, which I do need to mention. What the above rule does not take into account is the way that some companies use short term special offers to attract new customers, which can mean that the cost of borrowing is very low. This includes introductory 0% interest rates on credit cards, etc.
The main thing to say about these is that they do indeed turn the situation on its head and are a means by which you can actually make money from credit card companies. BUT, you cannot take advantage of this sort of offer unless you know that you are VERY disciplined and are happy to spend the appropriate amount of time moving money around to very strict deadlines. If this isn't you, then ignore this exception and work on the basis of the original rule.
Should I Pay Off Debt or Increase My Savings:
But Do It In The Right Order
If you are in a position where you have a fair few debts and some savings, you need to make sure you use your savings where they will make most difference. Assuming you do not have enough savings to pay off all your debts at once, it is important to identify which of your debts are costing you the most money.
Create a list of all your debts and what they are costing you in interest each month. Use this to identify where your savings are going to have the biggest impact. Use your savings to pay off the debts that are costing you the most money first.
