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Pay off debt or save? - Which is better in 2021?

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, look at which of your debts you might need to pay off first and how to pay off debt before you start saving.

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Should I pay off my debt before I start saving?

Paying off your debt or starting to save can be a difficult choice as they are both important, but it may make more sense to pay off your 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 is 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 debt.

Which debts should I pay off first?

It’s usually best 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.

Should I pay off my mortgage with savings?

You may 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 outgoings. 

You may want to balance paying off your mortgage with saving, as it’s also a good idea to keep some money in reserve, like an emergency fund, should the unexpected happen. 

Check out our guide on paying off your mortgage or saving instead.

Should I pay off debt with my emergency fund?

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 of 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? 

If you don’t have an emergency fund, paying off your loan or credit card debt before building one up might be the right choice as you could be debt-free quicker and subsequently be better off.

Should I pay off my debt or save for retirement?

The fact that more than a fifth of Brits don’t think they’ll ever be able to afford to retire 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.

Can I pay off debt and save at the same time?

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. You might also 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 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

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.

How do I pay off my debt before I start saving?

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 consistently pay off your debt (it might even help you pay it off quicker) and get on top of your finances. Try putting together a budget planner 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.

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 taxpayers and £500 a year for higher 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.

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