Pay off debt or save?
Deciding what to do with extra money.
If you find you have extra money, but already have some debts – like a home loan, personal loans, or credit cards – it can be difficult to decide whether to pay off your debts or start saving and investing. Here are some tips to help you decide.
First, build an emergency fund
Before you invest or make extra payments to repay your debts, save some money for an emergency fund. Things may be looking up now, but what if you lose your job or have a family or medical emergency? Many experts recommend that you save enough to cover at least three months of your basic expenses (food, power, fuel, rent/loan).
Think of debt payments as an investment
When you make a $100 repayment on a loan with a 13% interest rate, your annual return is 13% or around $13. That’s because you avoid having to pay that extra $13 in the future, which leaves you $13 more than you would have otherwise had.
Pay off debts that have higher interest rates than you get on savings
List your debts in order, from those that charge the highest interest rates (often credit cards, hire purchase or store cards) to those that charge the lowest (typically home loans). Pay off debts that have higher interest rates than the after-tax return you could get by saving or investing. Usually it’s quite hard to find an investment that offers a better return than paying off your high interest rate debts.
Make sure that saving doesn’t mean you get behind on your debt payments
If you don’t pay at least the minimum payments on all your debts – on time, every time – it can damage your credit rating (the number used by lenders to rate your ability to repay money, based on your borrowing history). You may also have to pay penalty fees and extra interest called default or penalty interest. These will cost more than the interest you earn from your savings.
