So is it better to save money or pay off debt? There’s no definitive right or wrong answer as to whether you should save money whilst still having short-term debt (credit cards, store cards, personal loans, vehicle finance, etc). There are however some considerations and things to think about.
Everyone’s financial situation, personal circumstances, thoughts on money and family life are all so drastically different and you should make the best informed decisions that you can.
The most important point to make is that you should know and understand your debt situation and have a plan about paying it off.
Debt is expensive
You may not realise just how expensive debt is, but it costs you money to have debt! Firstly, the interest rate on credit or store cards and personal loans is almost always guaranteed to be more than what you would earn at any bank on a savings account! These interest rates on debt are often in excess of 20%! That’s a lot of money you’re paying towards interest!
Imagine saving money in the bank at a rate of 5% but yet your borrowing money at a rate of 25%. That makes no sense, you would be far better off just putting your cash towards your debt. But, there is a bit of a mindset to change as we somehow feel better if we have savings, even if our debt is excessive.
Along with the high interest rates associated with debt, there are often additional fees and costs. Admin fee, membership fee (along with a silly magazine that no-one wants), annual card fees, additional card fees, lost card fees, etc. If you add it all up over a year you would probably be quite shocked at the full cost of your debt!
Looking at the cost of debt, it makes more sense to pay off your debt first before saving any money.
An emergency fund is super important
Having said that tough, having an emergency fund is super useful and important and this could potentially be more important to you than paying off your debt right now.
It’s situation dependent but having an extra R5,000 or R10,000 saved as cash which is specifically only to be used in emergencies can really be a life saver! When the car breaks down, the oven packs up or you need to pay an insurance excess for an accident. Even medical bills or pet emergencies can be covered by this.
Having some extra buffer in your budget is really vital and perhaps you want to consider saving for this whilst you’re still paying off debt.
But, an emergency fund is strictly ONLY for emergencies! Don’t be tempted to spend it on anything else!
Saving and generating more debt is silly
In the above section I said that you may want to save money for an emergency fund while you’re paying off debt. That to me is acceptable, however saving money and generating more debt is not acceptable.
In fact it’s quite pointless and a little bit silly to be spending wildly and actually creating more debt on one side and then pretending to be good at saving and putting some money aside.
You need to tackle your debt and your savings at the same time or rather only focus on debt. Don’t save money and carry on growing your debt as that makes no sense.
Cultivating the habit of saving is good
Saving money isn’t just important for the short-term savings goal that you set. Once you’re in the habit of saving money, planning and investing it you’ll find that it becomes a normal part of life and your finances will slowly improve over time.
It’s not about how much you save each month but rather the habit that you form and the fact that you become more conscious about your spending.
So save money or pay off debt?
Debt is expensive and paying it off should really be a top priority for you! It’s not worth having savings and investments which are growing at a lower interest rate than your debt. That’s almost similar to throwing your money away.
Imagine you have R50,000 debt (at 24% interest) and you have R50,000 invested (at a wonderful guaranteed 15% interest). This would cost you R1,000 in interest towards your debt (in a month) and you would earn R625 from your investment (in a month). That means it would cost you R375 for the debt.
However, if you paid your debt in full you would have no investment but you would also not be paying extra money. In fact you would then be able to start a new investment with the money you would usually pay towards debt along with the extra R350 that you would have paid in interest. You would be in a far better position.
Where to start?
I’m definitely not advising you to just cancel investments and pay off debt, but do some calculations. Open up a spreadsheet and work out how much interest you’re paying and see how you can pay it off as quick as possible! Have a look at this post on how to unwind the debt spiral. You might not be paying such a high interest rate and your circumstances are probably different to someone else’s. So it’s important to understand your own financial situation.
I cover this extensively in the guide to paying off debt.
Generally speaking it’s definitely better to pay off all your short-term debt before focusing on investing. But, it’s not a bad idea to have a small amount of savings for emergencies.
So save money or pay off debt? Why not both at the same time?
If you’re easily tempted you should even consider completely canceling all store & credit cards. If you want to reach financial freedom and enjoy the life you dream of then you’ll need to find a way to pay off your debt.
Being debt-free will be the start of an incredible financial journey.