Should I save or pay back debt?

Many will agree that savings are the key to good finances - but when you`re in debt, it can be difficult to know what your priorities are.

In an ideal world, we`d all like to make sure we`re building up our savings and repaying our debts as quickly as possible. But this doesn`t always make the best financial sense. Depending on how serious your debts are, you might find that taking care of your debts first could save you a lot of money in the long run.

When is saving a better idea?

Savings are always important. Most financial advisers agree that you should try to keep the equivalent of around three months` salary in savings to protect you against financial trouble.

Obviously, this isn`t possible for everyone - but the more you have saved, the better. Saving just a small amount each month is better than nothing at all.

If you`re in debt, it doesn`t necessarily mean you shouldn`t save. Many people manage to save money while repaying their mortgage, loans and credit card debts. The most important factor is whether you can afford it.

For example, if you`re managing your debts well and you have £300 left over once your essential costs are covered each month, you should be able to afford to put some of that into a savings account.

However, a lot of people argue it`s a better idea to `overpay` on your debts by as much as possible rather than saving, because the interest on debt almost always grows more quickly than interest on savings - meaning you`ll be better off in the long run. However, you could regret this if you ever run into financial problems and have very little in savings to bail you out.

When is paying back debt a better idea?

If you`re managing to pay off your debts and have a little left over each month to either save or overpay your debts, it can be difficult to decide what to do.

It`s a matter of maths: if you are saving money but spend the next five years repaying your debts with a 9% interest rate, you`ll pay more interest than you would if you overpaid on your debts and paid them back within three years. The returns on your savings almost certainly won`t be big enough to balance this out. (Just bear in mind that some lenders will impose an `early repayment charge` if you repay a debt faster than you originally agreed.)

With that in mind, if you already have some money in savings and you can see that your debts will be cleared within a couple of years, it may well make good sense to overpay your debts and clear them more quickly.

But you still might be at risk if you don`t have much in savings - so if you can afford to pay the regular amounts towards your debts and save at the same time, you might see that as the best option.

For more advice on saving and repaying debt, click here or call our expert advisers on 0800 195 2911.

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