Should I save or repay my debts?

For people struggling with debt, financial decisions can be difficult. On the one hand, there is the need to repay your debts; on the other hand, isn`t it a good idea to save some money, to better protect your finances in the future?

If you are in debt, in most cases the answer is no. If you are saving and repaying debts at the same time, you will often actually be losing money in real terms. Those savings would be much more effective put towards repaying your debts - and here is why.

Saving vs. repaying debts

As an example, let`s assume you have £500 in a savings account with an interest rate of 3%. Meanwhile you have £500 of credit card debt, charging an interest rate of 17%.

In a year, 3% interest would add £15 to your savings balance, leaving you with £515. In the same period, 17% interest on a £500 credit card debt would amount to £85.

Because the credit card interest is so much higher than the savings rate, the debt grows more quickly than the savings - in other words, you would have paid significantly more in interest on the credit card after a few months than you would have earned through savings.

For that reason, it makes much more sense to repay your debts and incur as little interest as possible, and start saving after you have finished repaying your debts.

Savings and debt management

For the reasons stated above, it is not usually worth saving if you are repaying debts, but there are a few exceptions:

• If your debt has an exit fee / early redemption charge, then repaying it immediately with savings might be the more expensive option. If this is the case, it might be a good idea to put the money in a savings account until the interest earned offsets the exit fee or until no fee is payable.
• If you only have debts with a very low interest rate - for example, an authorised overdraft - then you will probably earn more in a savings account than you would save by repaying your debts.
• If you have taken out a debt consolidation loan with fixed monthly payments, lenders will not always allow you to make `overpayments`. In this case, having a separate savings account could put you in a good financial position once the debt consolidation loan has been repaid.

Note: certain debt solutions, such as debt management, are based on the maximum repayments you can afford, although they sometimes allow for contingencies which will in effect prevent you from making savings. If you already have savings, it might be wise to use these to repay as much of your debt as possible before entering a debt management plan.

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Tags: debt, debts, repay debts, repaying debts, should i repay debts, debt management, debt management plan

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