Pay off your debt and save

Pay down debt or try to save: which one would you choose?

Ideally, the answer is both! 

Let's look at debt repayment and savings strategies that can help you reach your financial goals.

Debt and savings: The general rule

While we wouldn't necessarily call it easy, there is a straightforward way to decide whether to pay down debt or save: Compare the interest rate.

If you can make more from the interest on your savings than you would paying down debt, such as a personal loan or credit card, focus on savings. If the opposite is true, target your debt first.

One important thing to keep in mind: Interest earned on a savings account is generally considered taxable income, so you need to compare your debt interest rate to the after-tax interest rate on your savings. If you want to understand how your savings are taxed you should contact your accountant or a registered tax agent.

Usually, the interest charged on your debt will be higher than the interest you can earn through a savings account. In most situations, your best bet is to focus on debt repayment.

There's always an exception

Having debt with no savings in the bank can be a major source of worry. You might be caught short if the unexpected happens.

Saving while you have credit card debt, or any other type, may not be the best financial decision when looking only at interest rates. But there's a lot more to life than percentages.

Having an emergency fund — a cash reserve you only tap into if it's absolutely necessary — offers a valuable sense of security.

How much you should have saved in your emergency fund really depends on your own financial circumstances. Experts have differing opinions on this issue, suggesting three months of your expenses all the way up to one year of income. However, it is important to get started building this fund, if you haven't already.

One of the best paths to debt reduction involves:

  • Creating a solid budget: Determine how much money can go toward debt each month while still paying for necessary expenses.
  • Cutting the credit card debt cycle: Only make purchases you know you can repay promptly. Remember that available credit is a key factor in your credit report, so consider closing some less-used cards, too.

If all of your free money goes toward paying down debt, what happens if an unexpected expense arises?

You could put it on credit, but that leads to more credit card debt. With an emergency fund, you have the cash on hand to address the problem, or at least help pay for it. That means more savings in the long run compared to the alternative!

How much is enough when you're saving money?

Having something in your savings is important for your peace of mind, and to cover emergencies. But you shouldn't keep saving as debt piles up.

As a general rule, set aside enough to cover between three months and one year of essential expenses in your emergency savings. Make the decision based on your personal circumstances, like how stable your job is.

Once you top off your emergency fund, consider using some or all of what's left over to pay down your debt.

Standard credit card interest rates are near 20%. You'd be hard pressed to find many investments, much less a savings account, offering anything close to that kind of return!

Paying down a chunk of your debt with money you already have means less interest. Why is that important? It frees up your spare cash and then builds your savings faster!

Getting the best deal on paying down debt

These days, the market for all financial products is incredibly competitive. This includes credit cards, personal loans and mortgages. By comparing products online, you can often get a better deal and reduce the interest rate you pay.

TIP: Your GetCreditScore dashboard includes personalised credit card and loan offers based on your credit score. Login to check them out.

If you have credit card debt, look at doing a credit card balance transfer to reduce the interest charged on your current balance to a 0% or at least a lower interest rate. If you can reduce your interest rate to 0%, it can give you the room to put some savings aside while you're still repaying your debt. This could help you kickstart your emergency fund!

TIP: Only apply for cards when you're sure they're a good fit. Too many applications for credit in too little time can knock your credit score down, and that's the exact opposite of what you want to do.

If you have personal debt and can't manage a balance transfer currently, look at using a debt repayment strategy, such as the debt snowball plan, to pay down your debt faster. 

If you struggle to stay motivated while paying off loans, the debt snowball plan could be an effective strategy to use. You simply pay off your debts in order of smallest to largest. This allows you to gain momentum as you can see the impact of your debt repayment faster.

TIP: Consider rolling your credit card balances into a single personal loan with a lower interest rate. You'll save money and only have to make one payment each month.

While it might not help right now, remember that paying down debt can improve your credit score and help you access cards with lower rates. If you commit to a long-term strategy, it can definitely pay off down the road.

The wrap

Trying to get ahead while you carry debt means juggling a lot of responsibilities.

A debt payoff often drains your spare cash and slows down your progress toward saving and investing for the future. It's often a smart move to pay down debt as quickly as you can. But having an emergency fund offers a sense of security and quick access to cash when you really, truly need it.

The right balance between paying down debt and saving is different for everyone. Take the time to get clear on your debt repayment vs. savings strategy. You'll likely get financial and peace of mind benefits, and be more likely to follow through and ditch your debt for good!

GetCreditScore can help you track your credit score via our free, secure and simple service. And now, you can quickly see a Credit Report Overview as well as key factors that influence your score, along with that all-important three- or four-digit number itself.

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Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.