Forgot password?

Should You Save Or Pay Off Debt First?

One question often stands at the forefront of personal finance: should you save or pay off debt first? This dilemma can be particularly challenging for those navigating the balance between building an emergency fund and tackling high-interest debt.

With both strategies playing crucial roles in financial health, making the right decision requires a nuanced understanding of personal finance principles. This guide sheds light on what UK residents should consider when deciding whether to save money or focus on debt payments.

Emergency Fund: Your Financial Safety Net

Before diving into the save or pay off debt debate, it is essential to highlight the importance of an emergency fund. An emergency fund is your financial safety net designed to cover an unexpected expense or emergency situation.

Experts typically recommend having enough money to cover three to six months of essential expenses, to make sure you can weather an emergency without falling deeper into debt. Without this buffer, a sudden emergency expense could force you back into the cycle of borrowing, potentially at higher interest rates.

Understanding Your Debt: Interest Rates Matter

When considering whether to repay debt or save, the interest rates on your debts play a pivotal role. High-interest credit cards, payday loans and personal loans can accumulate interest rapidly, making it harder to get out of debt.

The golden rule in deciding whether to save or repay debt hinges on comparing the interest rate of your borrowing to the potential return on your savings. If your debt carries a higher interest rate than what you could earn from a savings account or investment, it makes more sense to prioritise paying off debt.

Repaying higher interest debt, such as credit cards and payday loans, should typically take priority due to the more interest they accrue. Strategies like the debt avalanche method can be effective when you focus on repaying debts with the highest interest rate first. This approach reduces the amount of interest charged over time and streamlines your debt repayment process, freeing up more money to save or pay down other debts.

Balancing Saving and Debt Repayment

Once you have addressed high-interest debts, consider balancing saving money with tackling remaining debt. This might involve making minimum payments on your borrowing with lower interest rates, such as student loans or a mortgage, while diverting extra cash to your savings accounts, including retirement savings. This strategy ensures you build your emergency savings while slowly reducing your debt load and staying within your credit limit.

In some scenarios, saving should take priority. If your employer offers a retirement plan with enhanced employer matching, contributing enough to get the full gain can be more beneficial in the long run than paying off low-interest debt early. The employer contribution is essentially free money, offering a return on your investment that likely outweighs the interest on student loans, mortgages or other loans with lower interest rates.

Making the Right Decision for Your Financial Situation

Ultimately, deciding whether to save or pay off debt first is profoundly personal and depends on your financial situation, interest rates and goals. If you are dealing with high-interest debt, focus on paying that down first. Once you have managed your high-interest debts, work on building your emergency fund, while paying down the rest of your borrowing more gradually. Remember, personal finance is about finding a balance that works for you, allowing you to build a secure financial future while managing debt effectively.

In conclusion, navigating the decision to save or pay off debt requires a careful assessment of your financial circumstances. You can make informed decisions that improve your financial well-being by prioritising high-interest debt repayment, building an emergency fund and leveraging opportunities like employer retirement matching. Remember, making strategic choices about saving and repaying debt is a critical step towards achieving debt freedom and economic stability.

More Information

How to Stay Out of Debt

Talking to kids and young people about money

Credit Line vs Credit Cards

Or visit the Polar Credit Info Hub to continue learning about personal finance, loans and credit alternatives.