Is it better to have savings or pay off your debts?
By Mr Bankruptcy
3rd June 2024
Having some emergency money put aside for a rainy day sounds like prudent financial planning against the unexpected – whether that’s a big repair bill or keeping your head above water should you become unemployed.
But if you also have outstanding debts, does it still make sense to keep some savings in the bank as well? The peace of mind that you enjoy could be costing you money.
Safety first
Having a safety cushion against whatever life throws at you can be seen as a luxury during a cost-of-living crisis. But the received advice is that the minimum recommended amount you should have in easy-access savings is enough to cover for three to six months-worth of essential outgoings (bills, mortgage, food, fuel etc) until you can find another income.
It’s good to feel in control of your finances, so it’s not surprising that a survey by HSBC UK found that the average emergency fund in the UK stands at £7000. However, it also revealed that young adults have, on average, less than £1000 set aside for emergencies, showing how difficult it can be to plan for the worst.
The cost of having a financial safety net
Even though interest rates for savings accounts are higher at the moment than they’ve been for a while, the general rule is that bank interest rates for borrowers are usually higher than for savers. That difference is how banks make their money from your deposit.
This means that the interest you are probably paying on your debt is more than you will be earning from your savings account.
TV money expert Martin Lewis is a big advocate of paying down debts. He uses a simple example to show how someone with a £1000 credit card debt and £1000 in savings could save £180 a year by using their savings to clear the loan.
And his example doesn’t even take into account the effect of inflation on your savings or the fact that you may also be paying tax on the interest you earn.
Paying off your debt
In my blog I’ve written a number of posts on the best ways to pay off debts and reduce interest payments.
But the general rule of thumb is to pay off the most expensive debts first, usually in the order of: overdrafts, credit cards, store cards, then personal loans.
But what about future emergencies?
What happens, though, if you use your savings to clear a debt and then you suddenly need £1000 in a hurry?
That’s when you can use that cleared credit card as a source of emergency money to borrow when you need it. If the worst does happens, you’ll be no worse off than before, but hopefully you’ll have had some time to reap the benefit from reducing your overall costs.
And, of course, once you’ve paid off your debt there’s nothing to stop you from putting a little bit aside each month to rebuild that nest egg. If you like the idea of being in control of your finances, then you’re probably motivated to be a regular saver anyway.
You can also make your emergency fund grow and work for you by looking for an easy access bank account that offers the best interest rate.
You can get some good deals from online-only but make sure the financial institution you open an account with comes under the UK Government’s Financial Services Compensation Scheme., which will reimburse you up to the tune of £85,000 if fails.
Is it always a good idea to pay off your debt first?
Everyone has their own individual circumstances, and you may have a very good reason not to pay off a debt immediately:
- You might have a competitive fixed interest rate or a ‘0% interest for the first 12 months’ type of deal.
- You may want to build up a credit history if you need to take out a loan in the future.
- There may be a penalty for early debt repayment (mortgage lenders impose an annual maximum on the amount you can overpay).
- Student loan works differently and it may not benefit you to pay it off early and miss out on a write-off at the end of its term.
- A lump sum payment on a mortgage could save you £10,000s over its lifetime and cut the mortgage period, but you can’t retrieve that money and you may have more immediate plans for it.
However, talking to a qualified debt advisor can help you understand the best options available to you or your business, so that you can start taking the necessary steps to navigate your way out of debt. And sharing your concerns with someone else is much better for your mental wellbeing.
James Rosa Associates
James Rosa Associates is a firm of debt advisors and debt adjustors. With a supportive, non-judgemental and friendly approach, we offer a full range of advice and professional services to individuals and business owners/directors who face unmanageable debt and are looking for a solution, or to people involved in a civil or commercial dispute. As well as advice, our range of services include:
We are authorised and regulated by the Financial Conduct Authority (FRN665061) to work with clients to produce bespoke solutions to fit their specific circumstances.
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If you want to deal with an unmanageable debt, or bring a dispute to a swift and cost-effective resolution, then contact James Rosa Associates, ring 0845 6807217 or email enquiries@jamesrosa.co.uk to find out whether you qualify for our free consultation service.
Please be advised that all views expressed in these posts are those of the author and not of James Rosa Associates ltd.