Rising interest rate. Should you save or pay down your debt?

With some banks (Click here if you are keen to find out the difference between a neo bank & digital bank) increasing their flagship savings accounts for certain bonus tiers up to 7.8% a year, the saver in us may be tempted to start saving more for a rainy day.

Having a good saving habit helps in life events like creating an emergency fund, planning for retirement, buying a house or other big-ticket purchases. It is a good habit that all of us should try to cultivate as early as possible. However, if you have an outstanding loan such as a housing or business loan, things could get a little tricker.

For starters, these flagship accounts come with terms and conditions like having to spend more on their cards, and/or buying more things from the bank (e.g. taking up a mortgage or savings plan). Also, note that these are often a tiered interest rate which means that it applies to only a fraction of your savings, not the entire savings.

One of the ways banks make money is to take deposits from depositors, lend them out at a higher interest rate, and earn from the spread in between. More often than not, the earned interest from saving more is likely to be less than the interest you are paying for your loans.

For example, you earn 2% interest from your savings account but you're paying 24% interest on your credit card debt. It would not make sense to prioritize saving instead of trying to pay down your more expensive debts as soon as possible.

But in instances where the rates for some loans and the savings interest rate are much closer, beefing up your emergency fund first could be helpful. It not only gives you peace of mind but also prevents you from having to take up a loan (e.g. during a medical or other emergency) and eroding all the interest you saved by paying down your debt quickly. However, for some loans, early repayment might not be possible without incurring an early repayment penalty.??

When saving up for your retirement or children's education, interest rate aside, the very habit of putting money aside every month could be a valuable habit by itself.

In deciding if you should save or pay down your debt, a strategy could be not just looking at the savings interest rate solely, but comparing it between all your loans' interest rates and taking into consideration some of the intangible benefits mentioned above. You could also do both, but just a matter of which to focus more on and allocate your budget accordingly.

Constantly looking at refinancing your debts with other lenders, and comparing around in a lowering interest rate environment could really help in reducing the amount of interest you have to pay. In a rising interest rate environment, switching to a fixed rate from a floating interest rate could also prevent you from paying more interest on your loans. Interest saved is also money saved.