Is it better to have savings and have debts or have no savings but fewer debts?
Posted on: Thursday, August 25, 2011
by admin
What would you choose: have some savings and have debt or have no savings but less debt? Our experts give their advice on our blog.
IS IT BETTER TO HAVE SAVINGS AND HAVE DEBTS OR HAVE NO SAVINGS BUT FEWER DEBTS?
We often get asked, is it better to have an emergency fund (savings) and have debts or pay off your debts (or as much as possible)….
In our opinion, it is better to pay off the more costly debts with your savings. However, I know what you are going to say…”what if an emergency happens like my car needs work as it has broken down or if my roof has a leak?”. Well in those situations, you would have to use another mode of credit like a new credit card or personal loan.
The reason we recommend this approach is because most credit cards have an interest rate of 15-18%. Therefore, if you have a debt of £1000, it will cost you at least between £150-£180 per year in interest. However, if you have £1000 in savings with a rate of 3% after tax, you will earn £30 in interest. So, by reducing your debts you are actually better off by £120-£150. Debts* ‘usually’ cost more than savings earn, so it is better to clear them sooner rather than later as you will be better off.
*There are exceptions to this rule, when debts are cheaper than savings but you will have to be very savvy, dedicated and really understand your financial agreements to be sure that this is the case…
- If you have a personal loan but it has penalty charges for paying earlier, it may be better to hold your savings until there are no penalty charges or when the charge is lower.
- If you know there is a large expense coming, it may be better to use your savings for this rather than pay off the debt and then add a new debt.
- If you monitor your rates and are committed to moving your debts to other 0% interest free credit cards (called credit card shuffling) or if you have the opportunity to have a 0% overdraft, then moving your debts around will be cheaper and you can still have your ‘emergency fund’.
However, if you want to use your savings to pay as many of your debts as possible then you should review all your interest rates to decide on which debts are the most expensive. You must pay off the most expensive first otherwise you could be paying a higher rate and be worst off per year than you actually need to be. If you cannot pay off all the debts with your savings, then review your finances and formulate a budget plan i.e. decide on an affordable amount which you feel you can set aside to pay off your debts. If by looking at your outgoings you feel there is no cash available or you are actually overspending then contact one of our advisers on 0800 032 9352 who can talk through your options.
If you have a number of credit cards or personal loans i.e. over £10,000, a debt management plan or an IVA may be the best solution to ensure you only have one payment and the actual amount you pay is reduced.