Pay off debt or save?

If you’re looking to save money but have debt, the two questions you might be asking are, “should I pay off my debt or save money?” and “can I pay off debt and save at the same time?”. On this page, we’ll help you answer those questions, looking at which of your debts you might need to pay off first and how to pay off debt and save money on the side.

Deciding whether to use your money to pay down debt or save can be a difficult choice as they are both important, but it may make more sense to pay off your expensive debt, like loans and credit cards, before you start saving. That’s because you’ll typically be paying more interest on your debt than you would earn from interest on your savings.

Of course, it’s always best to check these figures as everyone’s financial situation and savings goals are unique, but if you are paying more in interest on your debt than you could earn from growing your savings, you might be worse off if you start saving before paying off your debt. This is especially the case when the debt you have is very high interest, which is often the case with credit card and store card debt.

As a first step, you might make a list of each of your loans and their interest rates, so that you can prioritise repaying the most expensive ones. Once you have this overview, you might try to see if you can lower the interest rates on any of your debts. This means you’re in a more informed position when weighing up paying off debt vs. saving.

After deciding whether to pay off debt or save, you can get to paying off the most expensive debts. One method is to first pay off debts that charge high interest rates, such as credit cards and store cards, as this is the type of debt that will cost you the most. After that, you can move on to less ‘expensive’ debts which charge a lower interest rate, but be wary of waiting to pay off debts with promotional rates that may have an expiry date, as these debts may soon turn into your most costly debt. Paying off your most expensive debts first can help you reduce your total costs, as you’re not letting the interest you owe grow over time.

Sometimes, it’s not a question of paying down debt or saving money, but rather using your savings to pay off debt. This decision will depend on your specific financial circumstances. After all, if you have more debt than savings, as many people do, you’ll still have remaining debt to address even after putting all your savings towards your debt.

In certain situations, particularly if you have a low income or limited funds, you may inevitably dip into your savings to settle your debts. That’s why it can be particularly important to prioritise your debts based on how expensive they are. Your savings can then be used on the most expensive debts first, and you are in a better position to start saving again.

Should I pay off my mortgage with savings?

You might not consider your mortgage to be a debt, but it is. And like any debt, the sooner you pay it off, the sooner you’ll have full control of your own finances. Your mortgage is different to other debts because it is much less flexible and usually has a lower interest rate.

If you can use your savings to help reduce or clear your mortgage, this can bring many benefits. Paying off your mortgage early can be a faster route to financial security and freedom, and also means you’ll have reduced monthly expenses. However, it’s important to bear in mind that some mortgage providers charge a fee for overpayments, in which case you may be better off sticking to the given payment schedule.

You may want to balance paying off your mortgage with saving, as it can be sensible to keep some money in reserve, like an emergency fund, should the unexpected happen.

Check out our guide to paying off your mortgage or saving.

If you have an emergency fund, or you’re building one as a safeguard against unforeseen future expenses, you could consider paying off your debt with this fund. This is, of course, a personal choice and not one that you should make without considering all your options first. You might want to think about the following if you’re considering paying off your debt with your emergency fund:

• If you don’t use your emergency fund, will you incur more debt than you’re able to cope with?
• Do you want your emergency fund to remain intact so you can access it if you need to?
• Could you grow your emergency fund while paying off your debt?
• Is paying off your debt the kind of emergency that your emergency fund is meant for?
• If you use your emergency fund to pay off your debt, how quickly could you build it back up afterwards?

It is generally recommended to have three to six months’ worth of expenses saved up for unexpected emergencies, and anything on top of that could go towards debt repayment. Remember, if you’re suddenly hit with a large unexpected expense, and you have no emergency savings to cover it, you could end up adding to your credit card debt.

If you don’t have an emergency fund, paying off credit card debt or other loans before building one up might be a practical method, as you could be debt-free quicker and subsequently be better off.

The fact that more than a quarter of Brits are concerned they won’t have enough to afford to retire comfortably shows how important it is to be debt-free and have savings when you reach retirement age. After all, this is your reward for years of hard work and the chance to do the things you’ve never had time for.

While it’s important to start saving for retirement as early as possible, paying off any debt you have first could enable you to save for your retirement more effectively. You might not want to dig into your retirement savings to pay off debt.

If you want to pay off debt and save at the same time, there are a few things to consider. As we mentioned earlier, it’s probably best to pay off your most expensive debt first, like credit cards or store cards. So, the decision whether to pay down a credit card or save is generally fairly straightforward.

However, it’s not always a matter of paying off debt vs. saving. For some loans, such as mortgages, you typically have fixed monthly repayments that you’re used to coming out of your bank each month. Repayment of other types, such as student loans, is income-based, and many people never pay their student loan off completely. In these cases, you may be in a good position to consider saving and paying off debt.

Similarly, if you’re managing your debt well or the debt is particularly cheap or interest-free, like credit cards with 0% interest, it can make sense to save some money. Depending on the type of debt you have, you don’t necessarily have to pick between paying off debt or saving cash.

Whether you opt to pay debt or save money (or both), you might want to compare different types of savings accounts to ensure that you earn a competitive rate of interest and can grow your savings pot. The savings accounts which offer the most competitive interest rates are typically the following:

Notice accounts

Notice accounts feature competitive variable interest rates and the flexibility to withdraw your savings after a set notice period. You can open notice accounts with a single lump sum deposit, and keep your account open for as long as you want.

Fixed rate bonds

If you have a lump sum of money that you’re happy to lock away for a set time at a rate that won’t change from the day you open your account until it matures, fixed rate bonds might be the right type of savings account for you. Fixed rate bonds are a risk-free way to grow your savings, and they usually offer more competitive interest rates than savings accounts that allow you to dip in and out.

Easy access savings accounts

An easy access savings account allows you to deposit funds, earn interest, and withdraw your money with fewer restrictions than with fixed rate bonds or notice accounts. Easy access accounts are one of the most popular types of account in the UK as they offer a good balance of flexibility and simplicity, and they’re typically easy to manage. They come with variable interest rates, which are often lower than accounts with stricter measures in place.

If you decide to pay off your debt before you start saving, it’s important to have a plan that you’ll stick to. This may help you to consistently pay off your debt (it might even help you pay it off quicker) and get on top of your finances. If you already know how to budget, try putting together your own budget plan where you can record and track your monthly income and outgoings, and identify where you could make day-to-day savings that you could use to pay off your debt.

It can be a good idea to try to keep on top of your credit card balance and carefully consider what to do with your money. Paying off your credit card balance each month not only helps to keep your financial situation under control, it can also bring peace of mind. Any substantial lump sums of money that come your way, for example, an inheritance, work bonus, or tax refund, could also go towards paying off debt or saving.

If you’re struggling to keep on top of your debt, it can always help to get in touch with a financial advisor.

What about tax and savings?

The majority of people don’t have to pay tax on their savings. However, if you earn over a certain amount of interest – £1,000 a year for basic rate taxpayers and £500 a year for higher rate taxpayers – you will have to pay tax on your interest savings. This is another reason why it might be more prudent to pay off your debts first.

Deciding whether to save or pay off debt can be easier once you’ve considered all your options. You can quickly and easily apply for savings accounts with attractive rates from a range of UK partner banks and building societies by registering for a Raisin UK Account. Once registered, simply log in to apply for free in just a few clicks.