IS IT BETTER TO PAY OFF A DEBT OR SAVE THE MONEY? This is an interesting question. If you need a quick answer. Here it is:
Yes. It is almost always better to pay off debt and save later. Than to save money, while you’re stuck in debt.
Now, let’s add some context.
First, what is debt? In this context, debt is a sum of money that is owed or due.
To create a common ground for this argument, let’s take loan debt as a case study.
Most loans are structured to encourage early repayment. A maximum time is given to repay the loan. You have 2 catches here:
- Pay early and enjoy some discount (usually a reduction of the agreed interest)
- Pay late, and you have extra charges (also called penalty fees).
Using this simple example, it is obvious that paying on time can actually save you some money. Both the reduced interest rate and the added penalty fee you would have to pay for late repayment.
On a more general note, when you’re in debt, you really do not own any income you have. It’s like saying that your savings is a mortgage for your debt. In that case, saving up might not be the best option, until you repay your debt.
Being in debt and trying to save might only make things worse. If the lender is a close associate and gets to know that you have some cash save-up somewhere while you owe him. You’d have ruined future opportunities, and now you’ll have an increased pressure to repay.
Does this mean it is bad to save while in debt? Not really.
For example, you can choose to invest your earnings to gain some profit, and then use the investment and the profit to pay off your debt. This makes sense, right?
But there is a clause…
DISADVANTAGES OF SAVING WHILE IN DEBT
- REPAYMENT DEADLINE
If the investment period is longer than your repayment duration, then you’re only complicating issues for yourself. The reason is because you might have your income locked at the time you need it most, that is, your repayment deadline date.
- DEBT INTEREST VS INVESTMENT PROFIT RATIO
A second thing to consider is, is your expected profit more than the penalty fee you’ll incur for late repayment? If that is not the case, then investing rather than repaying is counter-intuitive.
- POSSIBILITY OF INCURRING LOSES.
A third, but very important point to consider is this. No investment has a guaranteed profit return. If you hold back from paying off a debt, and the business does not yield the expected profit. Or worse still, if it leads to some losses, then you know that you’re stuck in double debt.
- CHRONIC DEBT IS AN EMERGENCY
While you might be tempted to save up emergency funds rather than paying a debt. It is good to note that chronic debt can still be classified as an emergency. Makes sense right? Imagine saving up funds that could have been used to pay-off a debt, or at least to pay it off in part, so as to appease the lender. Now you save it for an emergency that may not happen soon, and the lender your collateral. Of course, that will be a poor financial decision.
- POSSIBILITY OF BAD CREDIT RATING
Another vital point to always remember is, late debt can give you a bad credit history. If you’re reported to the credit bureau, you might hurt your future credit rating. If you’re stuck in bad credit when you have funds stuffed off in some savings account, you’ll be stuck in a situation that your savings might not be able to redeem.
In summary, paying off debt is better than saving your funds because:
- Most loans are structured to encourage early repayment
- You stand the chance of penalty fee if you pay late
- Unless you’re guaranteed more profit than your debt interest rate, late payment is counter-intuitive.
- Delayed payment can hurt your credit rating.
- A debtor is almost never at peace. Paying off can increase your self-worth, which in turn will help you to make better financial decisions.
- No investment has guaranteed success rate. Losing funds in an investment while stuck in a debt is double loose for the investor.
DISADVANTAGES OF PAYING OFF A DEBT
- You might not have funds to care for an emergency.
- Paying off debts with all your income can result in some short-term financial hardship.
- Some loans charge a repayment fee (penalty fee) during the first years of the loan. This is one of the odd times when repaying early is a crime.
SHOULD I SAVE OR PAY OFF DEBT?
The answer depends on what you find more important. But as discussed, paying off a debt has so much advantage compared to saving funds while in debt. But this is not financial advice. The decision remains yours, and so are the consequences of your decision.
SHOULD I EMPTY MY SAVINGS TO PAY OFF CREDIT CARD
Emptying your savings is something that you should only do as a last… last… final ditch… resort.
The reason is simple: There are better alternatives to paying off your credit card without emptying your savings. Credit cards like … allow you to pay off monthly. With this in mind, you can budget your income to meet the monthly repayment option instead of paying off at once and emptying your savings in the process.
PAYING OFF DEBT OR EMERGENCY SAVINGS?
Chronic debt can be an emergency situation. In the event of an emergency, a loan or credit can come handy. If you already have a bad credit rating, this might affect your chances of getting a loan to solve an emergency. The summary is off debt trumps saving for future emergencies.
PAY OFF DEBT OR SAVE MONEY? – TAKING A MORE BALANCED APPROACH
The argument between to pay off debt or to save or invest it is a delicate one. There is no holy grail on the best approach on debt repayment and saving. And no need to be dogmatic. But this simple rule should help:
Most credit card issue an Annual Payment Rate (APR) of 20% and above, while a stock interest rate bothers around 10%. If your Return on Investment (RoI), on your projected investment plan, is not guaranteed to give twice your credit card APR, with any late penalty fee incurred along the way, then your best bet is to pay off first. If you are guaranteed a high profit on investment (very improbable, I’ll say), and you have a high thirst for risk, then you might consider investing first.
Let’s cap this QA session with a Mark Cuban quote. In an interview with Kitco News Mark reported said:
“The best investment you can make is paying off your credit cards, paying off whatever debt you have.”
Do you agree with his assessment on the debt-savings-investment issue? Let us know in the comment below.