Which is best – Saving or Repaying Debt?

by Guest

In a sense, savings and debt are at two ends of the same ‘scale’. On the one hand, savings provide financial security, making it easier to cope in a financial emergency, and earning you interest along the way.

Debt, on the other hand, can be a real drain on your finances – eating into your disposable income every month, and costing you more than you actually borrowed because of the interest charged.

It’s hard to imagine anyone not agreeing that it’s much better to have money in savings than it is to be in debt! But this begs the question: what if you have both debts and savings? Should you focus more on saving or on repaying your existing debts? Is it possible to do both?

There are benefits and drawbacks to each of these approaches – and here’s why.

Focusing on saving

In general, the more you save, the more financial security you have. Some experts recommend that you keep the equivalent of three months’ earnings in a savings account, but more than this is even better (especially if you ever find yourself out of work for an extended period) – and even a small savings account is better than none.

For this reason, some people prefer to repay their debts as normal and put their surplus income into savings.

As long as you’re keeping up with the minimum required payments on your debts, you shouldn’t experience any problems with this approach – but as we’re about to explain, it doesn’t always make the best financial sense.

Focusing on repaying debt

There is a clear advantage to focusing more on repaying your debts than saving: you’ll pay less in the long run. Most debts accrue interest much more quickly than savings do, so by ‘overpaying’ your debts first you’ll be minimising the amount of interest you pay.
Paying off your debts more quickly could also reduce your overall risk of problems with those debts, because they won’t be a burden on your finances for as long.

In fact, if you already have money in savings, using that money to repay your debts could make a big difference to the amount of interest you pay on those debts in the long run. But keep in mind that this will reduce the amount of protection you have against financial emergencies in the future – so it may be an idea to hold some savings back, just in case.

Doing both

As long as you can afford to do so, this is arguably the most sensible approach: paying more than you actually need to towards your debts and putting money into savings at the same time.

Your savings will provide a degree of financial security, but you’ll still be repaying a healthy amount of your debts every month. You’ll be paying more interest overall than if you were focusing more heavily on repaying debt, but you’ll know that if you come up against any unexpected costs or financial problems, you’ll still have a reasonable amount of savings to fall back on.

Of course, you could be flexible: why not put a little more into your savings when you think you might need the extra protection (if you’re coming up to an expensive time of the year, for example), but put more money towards your debts the rest of the time?

Related resources:

Further debt advice from the Federal Trade Commission

 

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