Save Money or Pay Debts?
Even if you have debts, you want to have some spare cash. Maybe to go on a holiday or just to have reserves in case something breaks down. On the other hand, it’s the cheapest solution to pay off your debts as soon as possible (even if you pay meager interest rates). But what to do first?
In the last couple of days, I have been writing a lot about debts, loans, and borrowing money. While doing so, I regularly encountered the question: whether to save money or pay back debts first? Does this also apply to my student loan? And, what’s smarter to do: paying off the mortgage or save a bit early?
What is the smartest thing to do?
Well, it all depends. I am not a financial advisor, and this article isn’t advice on what the actual smartest thing to do is, as it’s different for everyone’s and depends on the situation. Of course, you can only spend every Dollar only once, and if you use it to pay off your debts, you can’t buy a new car. For most people paying off their debts is the smartest thing to do, but for some people, the situation is different. Because what if you need a car to get to work and you wrecked your current vehicle? If you then use all the money to pay off your mortgage a little quicker, your car loan might turn up more expensive. On the other hand, if you have a lump sum of cash and a car loan, you might pay off your debts first.
Because you never know what will happen in life, but also don’t want to sit on your money, which is costing you money, we created a list. Based on what I researched online, combined with common sense, I suggest doing the following:
- Pay off problematic debts
- Build up an emergency buffer
- Pay off expensive debts quicker
- Create a barrier to do fun things with or treat yourself from time to time
- Pay off your mortgage / save for later / save for your children’s tuition fees
6 Pay off student loans
Sound weird, right? Paying off expensive debts first, then save and then finally paying off all other debts.
When to and when not to pay off your debts
There are a few set ‘rules’ you want to take a look at to know whether it’s smarter to pay off your debts or save first. It dramatically matters what kind of debts you have and what interest rate you pay on those debts. Of course, also the amount of money in your savings account counts. Last but not least, it’s also important to know what you expect to happen within the next few months.
The kind of debts
The type of debts you have is the most important factor whether you decide to either save more money or pay off your debts. A debt that occurred because you didn’t pay your rent or mortgage in time isn’t the same as a student loan debt with a relatively low-interest rate.
Debts that should have priority over building up an emergency fund
Debts you got because of not paying bills on time are always prioritized over saving more money. The costs on these debts increase faster than your savings will ever grow. These kinds of debts are even more important to pay off than building up an emergency buffer. If you had an emergency buffer, you’d use it on these kinds of debts.
Loans for stuff you don’t have any more
Also, credits for things you don’t have anymore, like a wrecked car or a stolen bicycle, you should pay off quickly. There’s nothing left anyway, and it only costs you money. This includes loans that you’ve taken for a family holiday.
In this case, it should be your priority, however, to build up an emergency fund of about a thousand bucks and then pay these loans of quite quickly afterward.
Other debts and loans
If you have other debts for stuff you own, like an educational degree or your house, it depends on the costs (how much interest do you pay?) and on your needs (do you need money any time quick?) and what the most sensible thing is to do.
How much do you need to pay?
How much interest you need to pay is a second argument when deciding to either save or pay off debts.
In the case of problematic and other expensive debts
In the case of problematic debts (like not paying your rent or mortgage) and consumption credit (also called personal loans), the interest is always sky high. If you don’t pay your bills on time, it adds up even faster. A collection agency charges very high starting costs and very hefty interest rates, which might be more than the initial loan or bill.
Mortgages and student loans are often a lot cheaper. Of course, you get way less interest on your savings account compared to what you pay your mortgage, so you should always pay your mortgage or rent before saving any money.
How much do you already have?
It’s always smart to assess to see how much you have. If you don’t have any money at all in your savings account, it’s quite wise to start saving something, at least. At least the emergency buffer of a thousand dollars. After that, you have to start making choices. The higher the interest you need to pay, the less you should save, and the more and faster you should repay.