Saving vs Debt Repayment

As economic uncertainty continues to challenge personal finances, the age-old advice to “save, save, and save some more” remains a cornerstone of financial wisdom. Yet, with nearly half of US adults holding less than $500 in savings, according to a GoBankingRates survey, it’s clear that many are struggling to build a financial safety net. But saving alone may not be the best approach, especially for those burdened with the need for high-interest debt repayment.

 

Financial experts often underscore the importance of paying off high-interest debt before focusing on savings. The logic is simple: if you’re carrying debt with an annual percentage rate (APR) above 7%, the interest you’re accruing is likely outpacing any returns you could earn from savings or investments. This makes debt repayment a more urgent priority.

 

In 2024, the average credit card APR is a staggering 21%, while even the best high-yield savings accounts offer just over 5%. This discrepancy highlights a crucial point: saving while holding onto high-interest debt can result in a net financial loss. For instance, if you contribute to a savings account instead of accelerating debt repayment, the interest charges on your debt will likely exceed any interest you earn, effectively diminishing your overall financial standing.

 

But what if your debt has a lower interest rate? Financial planners generally agree that if your debt carries an APR below 7%, it’s possible to balance saving with debt repayment. This situation often applies to secured debts such as mortgages or auto loans, which historically have lower interest rates.

When Saving Takes Priority

Once high-interest debts are cleared, shifting focus to savings is advisable. Experts recommend prioritising savings for specific goals, such as:

 

1. Upcoming Needs: Setting aside funds for necessary and expected expenses, like home or car repairs.
2. Emergency Fund: Building a cushion of at least six months’ worth of expenses to safeguard against unexpected events like job loss or medical emergencies.
3. Retirement: Regularly contributing to retirement accounts, like a 401(k), to take advantage of compound interest and employer contribution matches.

 

When Debt Repayment Should Come First

For those with debt exceeding 7% APR, paying it down swiftly should be the main focus. The reasoning is straightforward: reducing interest charges will leave more room for saving in the future. Today’s financial landscape has seen rates on new car loans and mortgages creep above this threshold, making debt repayment even more critical.

For example, consider someone with a £6,329 credit card balance at 21% APR. By only making minimum payments while saving any extra funds, they could end up paying an additional £2,770 in interest over nearly four years. Conversely, if they redirect surplus funds towards debt repayment, they could be debt-free within a year and save thousands in interest.

 

Strategies for Financial Success

To maximise financial security, individuals should consider these strategies:

• Avalanche Method: Focus on paying off the highest APR debt first, while making minimum payments on others. Once the highest-interest debt is cleared, move on to the next.
• Automatic Payments: Set up automatic payments for debt and savings to maintain discipline.
• Lower APR Options: Look for opportunities to refinance debt at lower rates, such as using a balance transfer credit card with a 0% introductory APR.
• Maximise Savings Rates: Seek out bank accounts with higher annual percentage yields (APY) to accelerate savings growth.

 

In the end, balancing saving and debt repayment requires careful consideration of interest rates and long-term financial goals. By prioritising high-interest debt repayment and subsequently building robust savings, individuals can achieve greater financial stability and security.