Category: Debt

Debt

Should you use Savings to pay off debt?

There are many people that have debts but they also have savings as well. Some people think that they should use those savings to pay off the debt but others like to have some money to fall back on. Which is the best to do?

Firstly, it will depend on the type of debt you have and how much you have in savings. If you have good debt like a student loan or mortgage then it is not always wise to pay it off early. You will probably not have enough savings to clear the debt anyway. Even if you do have enough money, it may be better to invest it and you may get more from the return on the investment that you are paying out in interest payments on the debt. However, you need to make sure that you do not take too much of a risk with the money as you may find that you lose some or all of it and that would not be good.

If you have a very expensive debt such as a short term loan, credit card or overdraft then it makes sense to get them paid off as quickly as possible. The interest rates will be really high compared with what you can get in a savings account and even with a good investment account and so it is worth paying it off. You may worry that you will have nothing to fall back on if you do this, but you will still have your overdraft and credit card that you can use in an emergency. However, if you pay it off, it will be a lot cheaper and you may not even need to use them anyway. The only thing to watch out for is early repayment charges so make sure that you calculate how much they will be and check that it is still worth paying off early.

If you are saving up for something specific then the decision can be more difficult. You have to consider whether you are prepared to give up what you are saving for in order to clear debts. Only you can make the decision as to whether clearing the debt is more important to you or the item you are saving for. It may make financial sense to pay the debt and then start saving again. Without the interest to pay you will be able to afford to save more money and you may still be able to get what you want as quickly anyway. You will also have the joy of knowing that you saved up for something and could have it and you paid off your debts. This can be a great feeling.

Although it usually makes financial sense to pay off expensive debts with savings, the decision is not always about the cost. Some people like having savings to fall back on. There are people who even take out a loan to top up their savings account as they like the security of having money there. Although this does not make financial sense, if it gives them peace of mind, it could be worth it on a personal level to them. So it is not always a simple decision. However, do not be influenced by other people telling you it is worth having money to fall back on. Banks want us to do this so that we have debts and savings and they make more money out of us than if we pay off our debts and have no savings. So the thought that we should always have some savings probably came from them all along and does not financial sense.

The decision is also made more difficult by the fact that some debts are more worth paying off than others and it is not always easy to decide. An expensive debt that will just keep gaining interest such as a credit card is worth paying off, but a student loan may not be. In the UK you only have to pay back a student loan if you earn enough and it gets written off after a number of years. If you pay it back early then you may end up paying more, than if you just pay what is required each month. You need to carefully consider each debt and think about whether it is best to pay it off.

It is also worth thinking about the amount that is owed. If you owe a lot of money then putting a small amount of savings money against the loan may not make a significant difference. However, if you only owe a small amount you may be able to clear the debt or pay off a significant chunk of it and that could make a big difference. If you just compare how much you are getting in interest on te savings compared to how much you are paying in interest on the debt, that should allow you to make the right decision.