Should you save if you have debt?


 

“No”, and “Yes”!

“No” because the debt will be costing you interest at a rate higher than the interest you’re earning on your savings account.

“Yes” because if you pay yourself 10% of everything you earn, then you pay yourself this 10% before you pay any bills – including debt repayments.  Having money in the bank makes people feel happier psychologically.

The interest on a savings account here in New Zealand is somewhere in the vicinity of 2.75% – 4.25% per annum.

Depending on the type of debt you have, the interest you’re paying on debt can vary widely from as low as 5.00% for a home loan, to 27.95% for some credit cards.

If you are really struggling with multiple debts and you don’t have much disposable income at the end of the week, my suggestion would be to see if you can manage to pay yourself 10% of anything you earn.  But, instead of saving this money, put it towards the debt which is incurring the highest interest charges.

For example if you have a credit card with $2000 owing at an annual rate of 27.95% this debt is costing you $559 each year in interest.  If you can pay this credit card off sooner by making more than minimum payments, then you can put the money you were paying towards this debt towards the next debt you have which might be a car loan at 18.95%.

Keep using any money you were paying towards the previous debt/s to snowball the funds available for paying off your remaining debts.

If you had $2000 in a savings account, the interest it would earn you would be around $60 per year before tax (at 3% p.a.), so only $49.50 after withholding tax.

On the other hand, if you only have a home loan, you could benefit psychologically from saving 10% of everything you earn into a savings account.  The interest rate difference between what you’re paying on your home loan and what you’re earning on your savings is not significant – at least in the short term.

People tend to feel wealthier and cope with their working day better if they get to keep some of their wages.  This is the philosophy behind the “pay yourself first” principle.  No-one wants to feel that they are only working to pay bills.

Of course, any extra you pay off your home loan shortens the term of the loan and this can mean a considerable saving in interest over a number of years.

So, the answer to the question “should I save if I have debt?” is probably not the same for everyone.

My advice to those with high interest debt is to get rid of that first – as quickly as possible!

My advice to those facing 30 years of home loan payments is to save 10% of everything you earn so that you can see it grow and feel that you are keeping some of your hard-earned wages.  You could perhaps use your savings to make a lump sum payment off your loan next time the fixed rate comes up for renewal.  Ask the bank how much this extra payment will knock off the term of the loan.  They have calculators to work this out for you.

Whatever you do, just make sure you take stock of your financial situation and are aware of how much your debts are costing you.  Perhaps create a budget to see if you can make some extra payments to get debt-free faster!

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