Should you build your savings or clear your debts?

Knowing whether to use your savings to clear your debt is tricky. Ultimately, it comes down to interest. Are you paying more in interest on your debts than you are earning on your savings?

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Our research showed that UK adults accumulated credit card debt of over £220 during the festive period alone. And that pales in comparison to the average £9,246 of personal debt UK adults held at the end of 2020.

While 15% of UK adults are estimated to have no savings, research published by Money Farm, suggests that on average adults aged 35-44 in the UK have on average £5,995 in savings.

The question is…

Should you prioritise building your savings or clearing your debts?

It comes down to "interest".

If you’re being charged interest on your debts it’s highly likely that you are paying more in interest than you are earning on your savings.

For example, if you owe £1,500 on your credit card and are being charged 19% interest, and you have savings of £1,500 that you are earning 1% on, you’d be paying £285 interest on your card balance while only earning £15 on your savings.

Using your savings to clear your credit card debt would save you £285.

However, if your debt is on a 0% deal (as long as you cleared the debt before the 0% period came to an end) there’d be no harm in keeping your savings while paying back the debt in instalments.

You should also consider whether there are charges associated with repaying your debts early. If so, you need to determine whether those charges are more than the interest you are earning on your savings or not. If the fee for repaying back early is more then it may prove to be more economical to maintain your current repayment schedule.

Should you use all your savings to clear your debts?

To answer this question you need to consider your personal circumstances. If you’ll need access to fund immediately in the future then having a rainy-day fund is always beneficial.

You could also look at transferring existing credit card balances onto a cheaper rate (or even 0%) balance transfer credit card to cut the costs of your debts. Or alternatively, a debt consolidation loan could reduce the total amount you repay.

If moving your debt isn’t an option, holding back some of your savings just in case they’re needed could be a good idea, even if it does cost you a little extra in the long run.

The credit card exception

If the debt you are repaying is on a credit card, there might be little need to keep an emergency fund. If clearing your credit card debt could save you the interest payments each month, while still keeping the account open in case of emergency, you’ll still have access to emergency funds if needed.

But crucially, you might have had time to rebuild some of your emergency fund with the savings you’ve made from clearing your card (i.e. your monthly payment amount).

Clear your most expensive debt first

The reality for many people is their debt exceeds their savings.

Meaning, even if they choose to use their savings to repay their debt, they’ll still be in debt. If this is the case for you, your priority should be on clearing your most expensive debt first.

So, you should focus your savings on repaying the most expensive debt. Keep in mind, your most expensive debt isn’t necessarily your largest debt - it’s whichever you’re paying the most interest on.

You can also ease your debt strain by checking for ways to lower your interest rates. If your debt is on credit cards or store cards, a 0% balance transfer credit card will help you to clear your debt quicker as every penny you pay goes directly to clearing your balance, not on interest.

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Tags: Your Money, Credit Cards