Should I Use My Savings to Pay Off Debts?
Breaking into valuable savings to pay off debts is never very appealing. This is understandable - hefty savings are usually the result of years of hard work. By using them to pay off debts, it can seem like you no longer have anything to show for your efforts. However, you may be damaging your finances in the long term if you choose to save money rather than using them for repayments. This guide helps you decide if using your savings to pay off your debts is a good debt management option.
In this guide:
- What is the point of using savings to pay off your debts?
- Are there any exceptions?
- Will you be left with nothing?
What is the point of using savings to pay off your debts?
It is very probable that you are paying more interest on your debts than you are earning from money in savings. This means that if you do not use your savings to pay off debts, you will likely end up paying more in interest than if you just cleared them straight away, as the longer it takes you to repay your debts, the more interest will accumulate. As a result, though you may have to start saving from scratch, using cash you already have stashed away to clear your debts will save money in the long term, as you will ultimately pay less in interest.
So, the short answer to the question is yes. It is usually a good idea to clear your debts as soon as possible, in order to save money that would otherwise have been used to pay interest.
Are there any exceptions?
There are some exceptions where using your savings to pay off your debts may not be cost-effective. For example, if you have money outstanding on an interest-free overdraft or a 0% balance transfer card, these debts will not have higher interest rates than you are earning on your savings. As a result, clearing these is not as urgent. You should use your savings to clear as much of your more expensive, high-interest debt as possible, and then you may be able to keep some back if your other debts are interest free.
You should also consider whether you will be charged for clearing your debts early. This is likely the case with your mortgage, so check the terms and conditions of your deal before looking to overpay your monthly installments. If there is a charge for clearing certain debts so high that you will end up paying more to clear it than you are earning in interest for your savings, it will be uneconomical to do so. You will be better off paying the standard amount each month with the interest than coughing up the penalty fee.
Will you be left with nothing?
If paying off your debts will leave you with little to nothing in your savings, you need to think ahead and consider whether you will need money imminently. If it is likely that you will be needing money for something urgent in the near future, you should first look into borrowing at a cheaper rate. If you are able to find cheaper alternatives, then you may be able to pay off your debts while still keeping a sufficient amount back for future emergencies.
If, however, this is not an option, you should keep some of your savings back just in case, even if it costs you a little more in the long-term.