There is virtually no point in saving money whilst still harbouring expensive debt. In fact, paying this off is the first step towards a successful savings plan.
There’s a lot of pressure to build savings at present, with mortgages now requiring at least a 5 per cent deposit, and government pension reforms putting the onus back onto society to make their own provisions for later life.
But with an estimated 960,000 people in the UK struggling with credit card debt, the question is whether savings should really be top priority.
Reduce the Deficit
Simply put, debt costs more than saving earns. Cancel them out and you will be immediately better off.
To illustrate, someone who has £5,000 in a fixed-rate savings account will likely accrue around 2 per cent interest over a 12 month period, earning £100. If, alongside their savings, they have £5,000 on a credit card charging the average 13 per cent APR, they will pay £650 in interest over the same 12 month period.
In this instance, by paying off the debt instead of saving, you would automatically be £550 better off over the course of the year.
It’s Not an Excuse
Many people fall into the trap of not putting savings aside because they’re harbouring debt, but instead of concentrating their efforts to paying this off, they continue to make the minimum payment on their credit card or loan every month. Instead, it’s better to think of concentrating a big effort into eradicating debt as the first phase of a wider savings plan – so pay off as much as you possibly can each month!
If you think you can spare £60 a month, put it towards paying off debt rather than just paying off the bare minimum. It’s advisable to set a time frame for how quickly you can be debt free and making sure to stick to it – having goals will help you remain motivated and focussed.
What about My Emergency Pot?
There is a general hesitancy to let go of savings, even though clearing debt will help maximise savings over time. The idea of having some funds stashed away can create a false sense of security, however, whilst you still hold on to expensive debt, the interest you end up having to pay will probably swallow up any you could earn from a savings account.
However, if having no emergency fund makes you nervous, then perhaps it’s worth considering running one scheme beside the other. If you have that £60 per month, split it. Put £30 into saving and £30 into paying off that credit card.
Which Savings Account?
When you are ready to start contributing to a savings account, you will be faced with a wealth of different account options to choose from, including whether a tax-free Isa or a regular savings account would be the best option for your money. You will also need to consider whether you can afford to tie your savings up for a period of time, or would be more comfortable retaining access but accepting a lower return in interest.
Investing money into a savings account to secure the future financially is on everybody’s mind. However, only by being debt-free will you be in a position to maximise your incomings and start to prepare for the future.
This post is written by Ali Raza on behalf of http://aldermore.co.uk/. Ali has been working in the Banking Industry for several years and frequently writes about finance and SME Businesses.