If you have a debt and you want to save, you might be wondering whether to save or pay off the debt first. To make this decision, there are several factors you need to consider like interest cost and interest earnings on your savings. If you are in this situation, we will help you make the right decision.
Banks like you to save with them and borrow loans from them. You will notice that interest earnings on your savings are usually lower compared to interest costs on loans you borrow. This means that your loan grows at a higher rate compared to your savings. This then raises the question, should I save or pay off debt first? Let’s dive into it.
Save or Pay Off Debt?
Whether to pay off debt or save depends on factors like interest cost on debt and interest on savings. If your loan attracts higher interest rates compared to your savings, consider repaying debt first. When you first repay your debt, you get mental clarity and it becomes much easier to achieve financial freedom debt free.
However, if your savings earn higher interest rates compared to debt interest, consider saving while repaying your loan. However, this is a rare case to find savings earning higher interest rates compared to interest rates on loans.
Read also: Why is saving money important in life?
Should I Save or Pay Off Debt?
As a rule of thumb, the best idea is to first wipe off a toxic debt like a credit card loan. Loans with higher interest rates can grow very fast until you are not in a position to repay. Besides, the higher interest rates on loans can eat much of your budget and make you fall into a debt trap.
You can use the debt snowball method to repay your debt. This method involves paying off debt from smallest to largest. You then roll the amount you used to pay on small debts to pay off larger debts. The debt snowball method gives you small victories upfront. You get the satisfaction of having repaid some debts.
Saving While Paying Off Debt
In some rare circumstances, you can find a loan that attracts lower interest rates compared to savings' interest earnings. In such a case, it is wise to save while repaying debt. Interest earnings from your savings can help you pay off your debt faster.
However, saving while paying debt requires strategy, planning, and financial discipline. You need to come up with a budget and stick to it.
Related: Why is budgeting important in life?
Why Pay Off Debt First?
There are benefits that come with repaying debt first. They include:
1. Helps Improve Credit Score
Paying off debt first helps you improve your credit ratings. This can help you qualify for higher loans at lower interest rates. On the other hand, having a large savings account in your bank does not give you better credit scores.
2. Avoid High-Interest Rates and Penalties
The other reason you need to pay off debt first is to avoid penalties and interest on debt accumulating. If you are in a position to clear your loan soonest possible, the better. It helps you avoid penalties. Besides, if you take longer to repay a loan, interest accumulates and can get to a level you can’t manage.
3. Removes Mental Burden
When you repay your debt, you get mental peace and worry less. Besides, when you are debt free, you can focus on other financial goals. The money you used to pay as interest on your loan can then be directed into savings.
Related: Should I invest or pay off debt?
Summary of Whether to Save Money or Pay Off Debt
Whether to save or pay off debt depends on factors like debt interest cost and savings interest earrings. As a rule of thumb, you should first pay off your debts, find balance on yourself and then you can start saving. However, in rare circumstances, like when the interest rate on savings is higher than the loan interest rate, you can consider saving first.