It feels good to have some savings to fall back on when you need them but if you have credit card debts and loans to repay wouldn’t you be better off clearing those balances instead?
This is a classic dilemma and one that troubles many people who try to find the right balance between putting some money away for a rainy day and clearing some expensive loans.
Here is a look at questions you need to ask about your finances and how to try and reach the right financial decision. There is an illuminating and persuasive example when comparing interest rates, plus an overview of how to plan ahead and some tips on ways to find extra money.
You do the maths
The most convincing argument that comes down in favour of taking steps to prioritize being debt-free over having savings in the bank, is the comparison between what you are earning in interest on your money and how much you are paying out to hold a debt balance.
If you have a credit card balance or loan of £5,000 that is charged at 15% APR on the outstanding balance, you will be paying £750 a year in interest charges.
Compare that to having £5,000 in a standard instant-access savings account where the interest rate is 1.5% (if you are lucky enough to even find a rate that generous) and you will be getting £75 for keeping your money in there for the same period.
You don’t need a maths degree to spot the massive difference between the two figures.
Having money set aside in savings can give you a greater feeling of security and comfort, which is why most of us do it, but based on the above example that decision is costing you £675.
Look to the future
It simply doesn’t make any financial sense to keep paying interest charges on your credit card and loans if you have the money available to pay some or all of the balance off.
If you take a long-term view and prioritize clearing your debts, this will ultimately free up more money towards savings once you are debt-free or at least in a better position with what you owe.
It makes sense to tackle your most expensive debts first so that you get rid of the balances that are costing you the most in interest rate charges. This normally means clearing your credit card balance and then vowing to not use the card again unless you are confident that you can repay the balance in full when the statement arrives.
Finding extra cash
You probably think that the only way to get extra cash towards paying off your balances would be to take on another part-time job to boost your income.
That is not a bad idea but you can often find some savings out of your monthly expenses that you can then use towards clearing debts.
A good example of how to do this would be when you apply for insurance quotes for your car or home. Rather than automatically accept the renewal invitation you have been sent shop around to see if you can get cover cheaper elsewhere.
Follow that strategy with all of your renewals on broadband, mobile phone contacts, and other regular commitments, and you could potentially generate some significant savings, giving you more money to improve your financial position.
Saving is a good habit, but paying off debt is a good one too, so find a balance that works for you and your money.
Natasha Barker works as a personal finance consultant and is Mom to three kids. She writes articles about her top tactics for saving money and educating people on their personal finance choices.