Should You Pay off All Debts as Soon as Possible
Pay off Debts, or Keep an Emergency Savings Fund?
Feb 2, 2009
In these difficult economic times, everyone is constantly being urged to save. Also, many people are told not to pay off their mortgages early. So is it a good idea to have some savings and a certain amount of debt, or should you pay all debts off as quickly as you can?
The Basic Rule - Pay off All Debt as Soon as Possible
It always costs more, in terms of interest rates, to borrow than to save. Even low interest loans generally have a higher rate of interest than the best savings accounts. Therefore, those with any debts should forget the old idea of always keeping an emergency savings fund. Having both savings and debts benefits no-one except the banks. Individuals should use their savings to repay all debts, keeping an arranged overdraft or credit card for any emergency borrowing they may need.
Mortgages usually have a very low interest rate, less than most other debt. However, the same rule still applies – if the mortgage rate is higher than the savings interest rate, the saver would be better to pay off part or all of their mortgage.
Exceptions – Times When it is Better to Have Both Savings and Debt
The only exceptions to the above rule are those instances when borrowing is cheaper than saving. These include the following:
- Student Loans – these are at a very low interest rate, so it is better not to pay them back
- Penalties on Mortgages and Loans – for those locked into one of these schemes, it is better to save the money, if you will be penalized for paying it back early.
- Interest Free Loans – These are occasionally offered with new cars and similar items. Obviously, it is preferable to retain this debt and collect interest on one’s savings. 0% credit card deals are a similar offer.
Prioritising Your Debts
For those who can’t pay off all their debts at once, it is important to get rid of the most expensive ones first. These are usually credit card debts, which have very high interest rates. After that the individual should pay off the debts with higher interest rates first – note the APR (Annual Percentage Rate), as this gives the true rate of interest.
Doing the above should enable most people to substantially reduce their outgoings. Once this is done and debts are under control, they can look at ways of building up savings for emergencies. But this is the order in which it should be done.
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