Debt vs saving: should you pay off your debts or save?
Is it better to pay off debt or save? We explain
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It can be stressful to decide whether to save or pay debts off, especially if you’re uncertain about how best to focus your attention.
There is a lot to navigate amid the cost of living crisis. Rising energy bills, high food costs and increased petrol prices dominate our day-to-day finances. And tax hikes are on the way in April.
It means priorities like saving and paying off debt may be sidelined.
Worried about debt? You’re not alone. The total amount of unsecured debt, such as personal loans, overdrafts and credit card borrowing, has reached £400bn in the UK, according to research by accountants PwC.
It means the average household now has £16,200 in unsecured debt - this is up £1,000 from a year ago.
Meanwhile, 34% of adults have either no savings or less than £1000 in a savings account, according to UK savings statistics for 2022 from the Bank of England (BoE).
And almost two-thirds (65%) of people believe they wouldn’t be able to last three months without borrowing money.
Here, we examine whether it is better to pay off debt or save.
Debt vs Savings
Why repaying debt is often the best option
Managing your debts is a no-brainer but the place to start. By staying on top of all your debts, you will:
- avoid late payment fees
- avoid compounding interest charges
- protect your credit score - which you may need if you continue to need credit
You should absolutely prioritise paying off any expensive debt. These are usually, in order of interest rate levels:
- Overdrafts - banks can charge up to 40% for an overdraft facility
- Credit cards - the average APR on a credit card is a shocking 30.4%, according to data analyst Moneyfacts
- Store cards
- Personal loans
Currently, the best easy-access savings accounts will pay around 3% in interest on your money.
You might feel great saving £100 into an account like this. But when you’re paying a lot more interest on your debts than you can earn saving, you save more in the long term by using that £100 to pay off debt.
Should you always repay debt before saving?
There are exceptions for every piece of guidance.
A savings account that pays an attractive interest rate, like this savings account from First Direct that pays 7% (customers only), may be higher than the interest rate on your borrowing.
There are also situations where it can make sense to pay off debts and save money at the same time - especially if the debt is free like this credit card from Barclaycard where you get 0% interest on purchases for up to 25 months and you are managing it well.
The most important thing is to deal with the most expensive debts such as a high-interest credit card otherwise they will only grow bigger the longer they are left and potentially lead to late payment fees, compounding interest charges and a poor credit score.
Consider a 0% balance transfer credit card to allow you to save
A 0% balance transfer credit card lets you move debt from an old credit card to a new one with a 0% interest rate.
Interest-free periods of over 20 months are available: NatWest offers a fee-free 0% balance transfer credit card for up to 33 months to existing customers (though there’s a 2.9% balance transfer fee), while Sainsbury’s Bank offers a fee-free 0% balance transfer credit card to customers and non-customers alike (though there’s a 2.89% or 4% balance transfer fee).
This is a situation where it can make sense to pay off debts and save money at the same time.
Should you have an emergency fund?
Savings experts always talk about keeping between three and six months’ worth of salary in an easy-access savings account. This way you have peace of mind about any unexpected bills or changes in circumstances.
If you’ve paid off an expensive debt and you're meeting your obligations on other debts now is the time to try to build up some savings. Three to six months’ salary in cash may be ideal, but £1,000 is also a good start.
There are lots of ways to save: you can save £667 in a year with the 1p challenge while The Money Edit have also shared their favourite money-saving tips.
Is using all my savings to pay off debt a good idea?
It is a risky option for those who have savings and expensive debt to use their savings to pay off the debt - and start with a clean slate financially.
If you had an emergency you could use a 0% purchase credit card - but only if you are eligible for one.
Leaving yourself without any financial safety net is something to carefully consider. What makes sense on a spreadsheet and what makes you feel good will differ from person to person.
Read more
Katie is staff writer at The Money Edit. She was the former staff writer at The Times and The Sunday Times. Her experience includes writing about personal finance, culture, travel and interviews celebrities. Her investigative work on financial abuse resulted in a number of mortgage prisoners being set free - and a nomination for the Best Personal Finance Story of the Year in the Headlinemoney awards 2021.
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