Should you save or pay off debts?

Many people have some form of debt like credit cards, loans or overdrafts. But if you also want to save, which do you prioritize?

One of the most common questions when it comes to personal finance is whether you should pay off debt before saving or investing.

One key consideration is interest rates.

Generally speaking, the interest rates on debts can be higher than the rate you get on your savings. This means you may be paying more for your borrowing than you’d earn.

And if that’s the case, you could be better off paying down your debt first.

The exceptions

However, there are some cases when clearing your debt ahead of building your savings isn’t the wisest move.
For example, if you’re tied into the debt and face a penalty charge if you pay it off early, then it makes more sense to keep the cash in a savings account. You can then use it to clear the debt when the fee no longer applies, or it reduces significantly.

And if the interest rate is lower on your borrowing compared to your savings (also bearing in mind the tax you may pay) you may want to keep the debt and save.

What about investing?

Ideally, you’d have paid off all your high-interest debts, like credit cards and personal loans, before investing - or at least have a plan in place.  

There’s no guarantee that any returns you make on investments will exceed the interest you’re paying on your debts, so you may still find you’re losing money overall if you don’t clear your debts first.

You also have to consider the fact that your investments can fluctuate over the short term. The last thing you want is to be carrying debt and unable to pay it off because your investments have dropped in value.

Steps to paying off debt, saving and then investing

The fact that you want to save or invest is a positive thing. There are just a few steps you might want to consider if you’re carrying debt.

Step 1

See if you can move your debt to reduce the interest. For example, can you transfer your debt to another credit card with a lower rate without penalty?

This should give you a chance to pay off your debt without paying any further interest, as long as you make the minimum payments each month. Aim to also clear some of the outstanding balance, too.

Step 2

Make a list of all the debts you owe, the outstanding balances and the interest you’re paying. It’s also a good idea to check if there are any penalties applied if you overpay or pay the debt off early.

Once you have your list, you can then make a plan to start reducing what you owe. 

Step 3

Now with a plan in place or your debt sorted, you can begin to save. It can be a good idea to start with an emergency fund.

This is a pot of cash that you set aside just in case you lose your primary source of income or have to make a large, unexpected purchase.

Aim to save three to six months’ worth of outgoings in an easy-access account.

What next?

With your debt paid off and an emergency fund built, you can begin to start saving beyond that - and investing!
The fact that your debt is paid off should mean that overall, you aren’t suffering a net loss as a result of interest. And with your emergency fund built, you can keep a cool head about dips in the market. This is because you’ll already have a pot of cash set aside.

Remember, your investments can go up and down and you could end up with less than you started with. Past performance does not guarantee future results. The information provided is financial guidance and should not be considered financial advice.