The interest rate on your credit card is unattractive. You’re not paying much more than the minimum repayment each month off your balance. At the same time, you’re saving very little, if anything at all. If an emergency crops up, let’s say you need to pay for repairs for your car, or cover a medical bill, what are you going to do?
If you’ve only been making minimum repayments and you’re already loaded with credit card debt, taking out another financial product such as a personal loan to cover an urgent expense might not be an option depending on how your current situation has influenced your credit score. Despite already being in a difficult place with your repayments, you might have no choice but to add to your credit card debt.
You probably don’t need us to tell you that at some point, something is going to have to give.
The great news from your perspective is that you can take control of your financial situation, and potentially deal with your debts, while saving a small amount each month, too.
What Should You Do First?
Logic tells you that you should pay off your debts first, and then save later.
After all, no matter how amazing a credit card deal you have, if you’re not repaying your balance in full each month, you’re highly unlikely to make more in interest from a savings account than you will accrue on your credit card. Therefore, by paying your debts and reducing the cost of the interest you pay, you’re immediately improving your financial outlook.
However, let’s go back to the situation we described at the start of this article. With no savings, you’re going to end up making urgent or emergency purchases on your credit card. You’re effectively extending your own revolving debt circle!
As we can see, there isn’t necessarily a simple and straightforward answer.
The only certainty is that doing nothing is likely to be unsustainable for you and for your financial situation in the long-term.
How you should approach paying down your debt versus saving will depend on a number of factors, not least your financial circumstances!
Let’s take a look at the considerations you might need to make, and when paying down debt or saving might make the most sense.
How Much Should You Look to Save?
In terms of having a savings goal in mind, aim to save the equivalent of anywhere from three to six months’ worth of your regular expenses.
Building up this as an “emergency fund” will help to reduce your financial worries and even give you some flexibility if you’re thinking of a career change, for example. If your current job is making you miserable then you know you can afford to leave and you have the cash to see you through in the short term.
Give this some thought based on your own circumstances. How much do you need to save – how many months’ worth of expenses do you need to be able to cover – to feel secure and happy with your situation?
The key to saving is to break down your larger savings goal into chunks. Aim to save one-months’ worth of expenses, and then another, and so on. It will be easier for you to hit your mini-goals, you’ll feel good about achieving something, and be on the path to your overall target.
Why and When Should You Decide to Save?
There are a handful of situations when saving might be your priority over paying down debt.
If you have a credit card that is in a promotional period, such as 0% on purchases or balance transfers, this represents a good opportunity to save. You will need to remain mindful of your promotional period ending, your balance, how much interest will be charged at the end of it, and what this will make your repayments look like. In the short term, if you’re not paying any interest your minimum repayments may be relatively low, and in any event only be a percentage of the balance. This should give you some breathing room to save.
In the longer-term, if you’re able to be disciplined and use your credit card very little or not at all while paying off the balance, and can switch to another 0% promotion down the line, you might find yourself easily able to build up a sufficient emergency fund while repaying your debts!
Outside of building up your own emergency fund for use in the here and now, you might also be looking further ahead.
If your employer offers pension and retirement savings plans, try to contribute as much as you can. A good rule of thumb is to look at what your employer will contribute, then contribute as much as you need to for them to have to give you the maximum contribution themselves. One major benefit of making contributions to employer schemes is that they’ll be deducted directly from your salary, so you don’t “miss” having the money. Just treat your income as having reduced slightly.
Another upside of making such contributions is that, over time, your pension or retirement pot can grow significantly depending on how your employer manages it.
When Should You Prioritise Paying Off Debt?
Having high interest debts or accounts where you’re doing little more than making the minimum repayment each month are clear indicators that paying off debt should be your priority.
Even if in the short term you’re only able to pay a little more than the minimum repayment, you’ll start to significantly eat into the interest you’re paying, leaving yourself better off and giving yourself the opportunity to reduce your debts quicker.
While one option is to look at opening a balance transfer credit card, you’ll still be in a situation where you could start compounding interest as soon as any promotional period ends. You might be better off instead looking to consolidate your debts via a personal loan. With a debt consolidation loan, your repayments will have an end date, therefore giving you a date you will become debt free, assuming you don’t clear your credit cards with your loan and then start spending on them again. A debt consolidation loan will also give you a fixed repayment amount so you can plan and budget your finances accordingly.
When prioritising repaying debts, it is important to prioritise the debts themselves.
The example we’ve given here is to prioritise high interest debts. If your financial situation is such that you have a mortgage or a student loan, but these are very low interest in comparison to other financial products you have, you shouldn’t worry about paying off more than what is required, even though their overall balance is higher.
Although making additional mortgage payments will save you money in the long-term, in the here and now it isn’t going to reduce your regular payments or make your mortgage provider recalculate your interest rate. Unless you have a high interest mortgage for whatever reason, your focus is best served paying your other debts first.
What are the Potential Downsides of Focusing Mainly on Paying Off Debt?
The biggest downside of focusing on paying off debt is that you aren’t saving!
Without your savings as a safety net, you will find that you end up paying off your credit cards and then using them again pretty quickly. Having spent months, perhaps even years, clearing long standing debts, it isn’t going to feel good when you then find yourself back at the start of this cycle.
What is the Best Approach? Should I Pay My Debts or Save?
Being in debt is stressful, so you want to reduce and, if possible, eliminate your debts.
Having an emergency fund and that safety net of a few months’ worth of expenses saved can give you peace of mind, so you want to save as much as you can.
The great news is that you can do both.
Spend some time looking at your personal budget and incomings and outgoings. This might even be the first time you’ve really taken a closer look at your finances. What do you have coming in? What do you have going out?
If your outgoings are more than your incomings, then you’ll have to address this first and foremost. However, if you have money left over each month, what are you currently spending this on? Is this disposable income – and what you use it for – worth more than the stress reduction when you pay your debts, or the feeling of security when you build your savings?
If the answer is “no”, then you have found the cash to start making extra payments to clear your debt and start saving each month.
Remember, even if you only make small extra payments or save a small amount, in the long-term you’ll be making a hugely positive difference to your financial outlook.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product
* https://geocaching.com.au/. Accessed 2nd December 2019.
* https://govolunteer.com.au/volunteering. Accessed 2nd December 2019.