Should I pay down debt or save?
Whether you’re a graduate with a student loan, a homeowner with a mortgage or perhaps an over-spender juggling credit card balances, it’s likely you’ll be sitting on some form of debt in your lifetime.
How you manage this debt is important. Maybe you’re in good control of your repayments and are able to save after your monthly expenses have been paid. If, on the other hand, you have that sinking feeling of debt growing rather than shrinking, you might have thought about whether you should pay down your debt pile or starting saving and investing for your future. Let’s look at this from a few angles:
The numbers
Taking a logical approach and looking at things from a purely numbers perspective will tell you to pay down your debt first since the interest rate on debt is likely to be higher than the returns you will achieve from your investment (unless you are an expert investor!).
Try to consolidate your debt. Pay down your debt with the highest interest rate first.
The type of debt you have will determine the rate of interest you’ll be paying. Typically, your credit card balance will be around 20% APR whereas personal loans and mortgages will be lower so if possible, consolidating will reduce the overall rate.
Reducing your debt will also improve your credit score which will help later on in life if, for example, you want to buy a house.
Creating good habits
Getting into debt can be caused by a number of reasons - however, most people will typically have bad spending habits that have got them to this position. If this is the case, there is a discussion to be had around saving at the same time as paying down debt instead.
The act of creating a regular savings habit can sometimes be more powerful and meaningful than the interest you’ll save by not reducing your debt pile.
From a financial perspective, paying down your debt makes sense; however, if you do not have the habit of regularly saving, falling back into the same bad habits once you have managed to pay off your debt will bring you back to square one; the cycle repeats itself.
Mental relief
Unless you have always been surrounded by debt and are able to manage it, it can be a mental burden knowing you are in the red, living paycheck to paycheck. It can be exhausting thinking about it.
In order to reduce the mental toll, it can be tempting to pay down the small balances first to give you a sense of satisfaction that you’re doing something about it. However, the risk here is that when you’ve finished paying these off, you’re left with huge, seemingly insurmountable balances to pay off.
Having the right mindset is often under appreciated. As long as you feel positive and making the right steps to moving forward, stick with it.
So what should you do? There’s actually no right or wrong answer here as it really depends on you. If clearing smaller balances gives you momentum and boosts your desire to the others, that’s a good thing!
Examine why you got into debt
There is a reason you got into the situation which you need to know why so you can avoid it in the future. Understanding this and making changes is key to a healthier future. Here are some typical reasons and solutions:
- Living beyond your means
- Unforeseen expenses / medical costs
- Loss of job
- Death in the family
All of the above are not totally avoidable, however, you can prepare for them in case they show themselves.
- Get yourself adequate insurance to avoid falling into debt even if you have a positive balance right now.
- If you problem is overspending, you’ll need to set yourself a monthly/annual budget so you can you control yourself.
- Maintain a rainy day fund of 3 months worth of expenses which will protect you in case of any emergencies.