It’s easy to feel pressured to have a savings account or some type of investment. Is it better though to be saving or to be paying off debt?
Let’s have a look at some ways to calculate the answer…
Generally speaking (and almost always) the interest that you earn on savings is far less than what you would pay on debt. Let’s look at an example…
You bank account may give you 4 – 6% (as an example) and fixed-term savings accounts may give you a bit more. Unit Trusts or other investments will probably be even more although they vary each month but you can get a general idea of the growth by looking at an investment summary sheet.
Debt – whether on store accounts or credit card is often charged a much higher interest rate. Add to that “fees” and penalties and all sorts of made up costs. Store accounts are designed to trick you because they often offer 3 or 6 months interest free debt, but remember that they charge you other fees each month (club fees or Special Member fees). And, if your debt is not paid within the interest-free period, they hit you with very high rates.
Thus; find out the interest that you would earn if you save your money and find the interest that you are charged (look for your account where you are charged the highest interest). That should give you your answer. Most of the time it is better to pay off debt!
Tip: If you have a home loan that you can access (pay extra into and withdraw when you need it) then you can save money by paying off your loan. If you pay extra into your loan account you will earn interest at the rate of your loan (currently in South Africa home loans are offered at around 12% interest). This is a good way to save for emergencies but at the same time you are paying off debt.
The Cost of Debt
Let’s look at a simple example of how much debt can cost you. If you have 1000 and you put in in a savings account for 1 month with an interest rate of 4.5% you would earn 3.75 interest. If you owe 1000 on a loan and the monthly interest rate is 20% you would pay 16.66 in interest.
Thus, if you “save” your 1000 for the month it is actually costing you money! You will have to pay 16.66 interest on your loan and yet you only earn 3.75 on your savings. You have to pay 12.92.
In this example, if you choose to save the extra money, it is actually costing you money and not saving at al!
Did you know that is most cases (if not all) the creditor (person or company you owe money to) can call up your debt at any time and insist that you pay it immediately. This is especially true for banks who can call up your home loan. This would put you in a terrible situation and could be disastrous to you and your family.
Debt always comes with a risk and therefore it is better to pay your debt as quickly as possible! Being in charge of your money means that you minimize risk by knowing and understanding the consequences of what you do.
Peace of Mind
Having debt causes stress. It’s not nice knowing that you owe someone money and especially if you are struggling to pay it. The consequence of not paying your debt can be dire and this all adds to your stress levels.
If you have the choice of saving 500 in your bank or paying debt off you should consider the peace of mind that you could “buy” yourself. Having no debt would be a wonderful feeling so if you can get to that state by slowly planning, budgeting and working towards being debt-free this would bring great relief to life.
It is probably a good idea to have a small amount of savings that can be used for emergencies; but generally speaking it is far better to pay off debt rather than save. If you have any spare money at the end of the month work towards paying off your debt!
Have a look at this article on paying off your store cards and apply that principle to any forms of debt that you may have.