If you have some extra money after you’ve paid all your bills every month, you might be wondering which is better: save it or use it to pay off your debt? Here are the questions you should ask yourself to figure out what’s best for you.
Debt is a fact of life. It’s pretty much impossible to pay cash for everything, and a bit of debt is essential for building up a good credit record. But which is more important: paying off that debt, or setting your spare cash aside in a savings account?
It’s a tough question with no easy answers, but here are some factors to consider when you decide which is best for you.
Factors to consider when deciding between saving or settling debt:
What are the emotional taxes of your debt?
It may seem a strange place to start, but debt isn’t only a financial issue: being in debt can have a significant impact on your stress levels – and on your family’s too. A 2016 Dartmouth College study found that some of the debts that parents take on could have adverse effects on their children’s socio-emotional wellbeing, creating what study author Professor Jason Houle called a ‘double-edged sword’.
‘Debt can bridge the gap between your family’s immediate economic resources and the costs of goods and therefore can be a valuable resource, but at the end of the day, it has to be repaid with interest and sometimes with a great deal of interest when it comes to unsecured debt,’ he explained. If your debt burden is taking a heavy emotional toll, it may be best to prioritise those debt repayments.
What interest rates are you paying?
Sometimes the debt/savings debate simply comes down to the numbers. If you’re paying sky-high interest on your debt and earning relatively low interest on your savings, then you’re paying more than you’re earning. In other words, you’re losing money.
This is where the concepts of ‘good’ and ‘bad’ debt come into play. A home loan, for example, will have a long-term payment plan with lower interest rates on an asset that grows in value. A store card account, on the other hand, usually comes with high interest rates, and you’re paying for something that’s losing (or lost) its value. It’s best to avoid those ‘bad’ debts – or to settle them as quickly as possible.
Are you earning more than you’re burning?
Digging deeper into the previous question, it’s worth seeing how your loans/debts stack up against your savings. Depending on where you bank, the interest on your credit card debt could be anywhere from 9% to 20%. You’ll struggle to find a bank that offers anything near those levels of interest on your savings account. TymeBank’s innovative GoalSave is a rare exception. It’s a free savings tool linked to your EveryDay account, and it offers interest that gets bigger over time. You’ll get 4% interest from day one, 5% after 30 days, 6% after 90 days and 7% if you give the bank 10 days’ notice of any withdrawal after 90 days.
Do you have an emergency fund?
While it might be scary to watch your debt grow faster than your savings, there are some situations in which it makes sense to grow your savings first, before taking care of your debt. An emergency savings fund is a great example. Imagine what would happen if you threw all your money at settling your debt, and then had a financial emergency? You’d be debt-free, but you wouldn’t have any savings to draw on! An emergency fund will cover small but urgent expenses such as car repairs, home repairs, job loss, unexpected travel, etc. For the sake of your financial future, it’s vital that you have some savings stashed away.
What are your financial goals?
If you’re dreaming of a comfortable retirement, then you’ll have to save. It’s as simple as that. The National Treasury estimates that only 6% of South Africans will have a decent retirement, while recent research found that about 50% don’t have a retirement plan at all. The stark reality is that a pension fund or retirement annuity alone will likely not be enough; you might need to supplement that with savings and other investments as well.
How about a bit of both?
You’ll have noticed by now that the best approach when it comes to saving or paying off your debt is to do a bit of both. A blended approach lets you take care of your most urgent debts (particularly any ‘bad’ ones), while still building up an emergency fund and saving towards your longer-term financial goals.
Say you have R1,000 to spare. You could, for example, set up a debit order to automatically contribute R500 to your debts, while putting the other R500 into your savings. (How you ultimately balance those amounts will depend on your personal circumstances.)
Yes, you’ll lose a bit more in interest by not being completely debt-free straight away… but at least you’ll know that you’re steadily building your wealth.
Start saving today
Putting your money into savings is made easy with TymeBank GoalSave. Open a GoalSave account today and start watching your money grow. Not convinced yet? Check out TymeBank’s GoalSave calculator and see for yourself how much money you can save.
Disclaimer: This content is for informational purposes only, and should not be construed as legal, tax, investment, financial or other advice.