It’s a dilemma faced by many people, to leave savings where they are or pay off outstanding debts. For a lot of people, having some savings behind them makes them feel ‘safe’ but this feeling of safety really shouldn’t outweigh logic.
To be honest, it’s pretty simple, other than the odd exception, you should always repay your debts before embarking on saving. The reason for this is that debt is generally expensive, and the cost of debt is usually a lot more than can be earned on savings, especially whilst interest rates are so low.
If you had £2500 on a credit card, with an interest rate of 15% – you would owe £375 in interest
If you had £2500 in savings, with an interest rate of 1.5% (after tax) – you would earn £37.50 in interest
Therefore, it’s costing you £337.50 to keep the debt instead of repaying it. Pay off the debt with the savings held, you’d save yourself that £337.50!
Exceptions to the rule;
1. Your debt is interest free – if this is the case then, as long as you keep your eye on when the interest free period ends, you can repay the debt gradually whilst earning interest on your savings held. The aim should be to repay the debt before the end of your interest free period, or if this isn’t possible, then to transfer it to another interest free option (ie a 0% interest credit card) at the end of the term. It’s important to note however, that there will often be a fee for a balance transfer which you need to factor in. This balance transfer fee could cost you as much, if not more, than you are earning on your savings making this process false economy and if this is the case, you’d be better repaying the outstanding debt with your accumulated savings.
2. There is a penalty to repay the debt – if there is a penalty to repay the debt early, as can be the case with some mortgages and loans. In this case it’s better to leave your savings where they are and either let the debt run it’s course or wait until the penalty is small enough that it won’t cost you more than the interest that you are earning on your savings.
Finally, don’t forget to pay off your most expensive debt first and then crack on with saving!
If you have any questions or would like information on savings and investing, fee free to get in touch.