Debts First, Savings Second

It seems that since the credit crunch took hold and the banks curbed their enthusiasm for lending, there has been a misconception amongst financial institutions that people are now in a position to open savings accounts.

Whereas the media was once awash with adverts for loans and credit cards it now only offers insights into the best investment vehicles for our money.

This new tactic could potentially lead to people having a false impression of their financial situation and could also lead to the banks making twice the amount of money out of us.

If people are being encouraged to open savings accounts whilst still paying down debt then there is a good chance that this debt will then take longer to pay off and the banks will make more money through a prolonged payment period.

In addition, they will most likely be making money by sitting on the cash that you are putting away in savings!

And because the rates of interest charged on loans and credit cards are far higher than those paid out on savings accounts then this effectively makes saving whilst paying down debts counterproductive.

This is why you should fully take stock of your financial situation and try to pay down your debt before embarking on any savings scheme.

So if you do owe money through loans or credit cards, how do you go about paying down this debt so you can start saving?

The first thing you have to do is to work out exactly how much debt you are in, taking into account loans, credit cards and overdrafts a and then decide upon the best way to pay it off.

These calculations should include any loans, credit cards, and overdrafts, and there is no need to factor in mortgage payments. Once you have a total you then need to work out how long it will take you to pay it back.

One of the best ways to work out how long it will take to pay your debt down is to create a personal budget that takes into account all of your income and expenditure.

To create a personal budget you need to work out exactly how much money you bring in each month and then calculate your total outgoings, including mortgage payments, utility bills, grocery bills, fuel bills and any everyday expenses such as train fares or newspapers. You also need to factor in annual expenses such as car and home insurance.

You then need to subtract you total expenditure from your income and the figure that you are left with is the amount that you should be able to pay off your debt each month.

And, once you have this figure to hand, you should then be able to calculate how long it will take to pay off your debt and work out when you can start saving.

This should also be used as an opportunity to review your spending and see where you can save money, whether through cutting back on everyday spending or switching credit cards or utility providers, as this may enable you to pay down your debt sooner than expected.

In addition, when paying down debt it is important that you don’t add to it, so there can be no loan extensions or any more spending on credit cards.

The important thing to remember though is that saving whilst paying down debt will most likely be counterproductive, so pay down debt first and make savings second.

10 Responses to Debts First, Savings Second

  1. Justin @ MoneyIsTheRoot says:

    You definitely need to pay down the credit card debt before you worry about savings massive amounts of your income. However, I dont know that I would include the car loan in there. Sometimes the rates can be very low for these, and you need to have some amount of liquidity available. Also, you can generally outpace those rates with an investment account.

  2. Frugal Living says:

    I am not worried about paying down all of my debt right away because I have a lot of good debt and a lot of bad debt.

  3. I think it depends on a few factors- whether its “good debt” or “bad debt” and also how much is the interest on the debt?

    Of course if one had credit card debt at the rate of 29.99% per month, one should definitely not be saving $50 a month in a 1.5% yielding GIC :) Priorities, people, priorities! :)

    Great post!

  4. I don’t necessarily agree that you need to pay off your debt 100% before beginning a savings account. Actually, it’s a good idea to a have a small ER fund built up while paying down debt. And, for those people who are paying off student loans or other low interest debt, I believe you still need to be saving money while paying off debt. Otherwise, you might not get to saving anything for a very long time – and that messes up compounding interest.

  5. Ravi Gupta says:

    I agree with Little House. I think you should save a little before paying down debt so you have a bit of a safety net. If you don’t and something unforseen happens then you will have to revert back to credit cards and the cycle begins anew.

    -Ravi Gupta

  6. Wojo says:

    I think balance is the key–a little (or a bit more) liquidity is important, especially if your job is on the rocks, so saving first might make more sense. Also, I would never make a decision based on how my bank (or anyone else) might be profiting off something I’m doing–I’m just going to do what’s best for me and be done with it! :)

  7. stuart/edinburgh/scotland says:

    i agree with little house

    small but regular savings while paying off debt/gets you into routine saving

    once debt paid off-increase savings

  8. CA Karan Batra says:

    Repaying the Debt rather than opting for Savings is always a better option as Interest on Loan is always higher than the Interest on Deposits. But the problem in countries like India is that Banks also have a prepayment charge. In case you pay off your debts before the scheduled time, Banks charge a hefty penalty for the same which is unjustified.

  9. It always makes sense to pay of credit card debt. If you think about it, you will get a guaranteed 15% (or whatever your interest rate is) return on your money. There aren’t alot of investments that can guarantee that type of return

  10. dianne says:

    i think if we can do both saving and paying at the same time.. we should do. just try to analyze how to budget in dividing the money for paymeny and the money for savings.. at least save a little while your paying debts

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