What Should You Do First? Pay Off Debts or Save? – Baby Budgeting

Saving is an excellent way to prepare for your future, and you should endeavour to start saving as soon as possible and as much as possible. However, an essential consideration is whether you should prioritise saving over paying off your debts.

Generally, it is more financially prudent to eliminate your debts before saving. Read on to discover why.

 

Why Should You Prioritise Eliminating Your Debt?

You must understand that servicing your debts will, generally, cost you more than the money you can make from interest on your savings. Interest rates on borrowed money are higher than those offered in savings accounts, so debt interest payments will wipe out the gains you make on your savings.

For instance, saving interest rates are typically around 1.5%. However, these are dwarfed by the interest payments you’ll make on credit card loans, currently approximately 19%. That means you’d earn around £15 on £1,000 savings, whereas you’d pay £190 interest on the same size of credit card debt.

Of course, saving is a great habit to develop and should be encouraged from an early age. However, it would be best if you always tried to get your debts eliminated before starting to save.

When paying off your debts, you should first concentrate on those with the highest interest. That’s because these are the ones that will cost you more as your outstanding balance accrues compound interest.

 

 

Exceptions to the Rule

Of course, there are exceptions to the debts-before-savings rule, as there are with most things. Let’s take a look at three instances where it may not be beneficial to clear your debts:

1. Where Repayment Charges Apply.

Some debts, such as fixed-term mortgages, carry early repayment charges. In these circumstances, you could pay thousands of pounds in penalties if you repay debt early. In many cases, these penalties amount to much more than you would make from a savings account.

Therefore, paying off the debt early makes only financial sense if you can find an interest rate that earns you more than the charges. It could be worthwhile sticking to your repayment schedule and keep saving until the penalty period ends.

2. Student Loans.

Student loans are an anomaly as far as your debts are concerned.

Interest rates on these loans are kept in line with inflation, and you don’t have to repay them until you earn a certain level. Also, eventually, your loan provider will write off your student loan. Therefore, there are no financial benefits from paying off these loans early.

3. Zero Percent Interest Loans.

Brands are so keen to get your business that they often offer interest-free borrowing for specific high-ticket items. When you have a 0% interest rate period, it makes little sense to pay off the debt during this time.

The same applies to some credit cards. Providers will attempt to lure you away from your current lender by offering 0% interest on purchases for a set period.

In both cases, it could be more beneficial to stick with the 0% loans and save throughout that period. Of course, you should ensure you pay off any outstanding balance before the interest-free period ends. Failing to do so means that the rates could skyrocket and wipe out any savings gains you’ve made.

 

Is Saving Still a Good Idea?

Saving is undoubtedly a great habit to develop, whether as an emergency fund, retirement fund, or saving for a specific event. However, if your debts cost more than you can make from savings interest, you should eliminate these first. Money management and planning for the long term financial future is important. Speaking to a specialist and taking on expert advice is helpful. Check out Portafina.

As we mentioned, there are a few occasions when you can prioritise saving ahead of eliminating debts. These situations are mortgage repayments, student loans, and interest-free borrowing. For every other occasion, it makes financial sense to clear your debts before you start to save.