Should you Save While in Debt?

Many people who are in the process of paying off debts find themselves facing one particular dilemma. Should they aim to build up some savings for the future at the same time as paying off their debts, or should they focus all their efforts and available funds on clearing what they owe?

When Britons are being urged to save more, it is a difficult decision to make. There are two key factors that need to be considered in order to decide which approach is best.

What Will Leave you Better Off?

The question of which approach will leave you better off is surprisingly easy: you will be better off by focussing all your efforts on repaying your debts. Suppose you have £1,000 and are trying to decide whether to put it into savings or pay off £1,000 worth of debt. Putting it into an ISA will likely get you around 2.75% interest at best. This will earn you something in the region of £27.50 over the course of the year. If a personal loan has a fairly attractive APR of 8%, then leaving that £1000 worth of debt in place will cost you £80 in interest over the course of the year, leaving you more than £50 worse off. In other words, thanks to the fact that loans and credit products almost always have much higher interest rates than savings accounts, you will be better off repaying debts before you think about putting money into savings. Most financial advisers will recommend this approach because it will ultimately leave you with significantly more money.

Unexpected Expenses

On paper this seems simple enough. You stand to gain a lot more from paying off debts than building up savings. However, the danger of some unexpected expense complicates things a great deal. If you put every penny you have into paying off debts, then you might end up in trouble if your car breaks down or your home needs some form of repair. The last thing you want to do when struggling to pay off debt is put yourself in a position where you need to borrow again. If you do not currently have any savings at all but you are earning enough to have money left over after meeting your minimum repayments, then you might want to build up a small amount of savings. This will serve as a buffer to protect you if the unexpected happens. Once you have a little bit “for a rainy day” you can then shift your focus more wholeheartedly onto clearing what you owe.