With the current cost of living crisis in the UK, many people feel the squeeze. In these trying times, it’s essential to make sure we’re making the best financial decisions for our money situations.
Should you prioritise paying down debt or stack that additional cash? It’s a loaded question that, at first, may seem quite simple; of course, you should pay off your debt before saving money.
However, it’s not that simple. There isn’t a straight right or wrong answer. It boils down to whether you want to apply a mathematical or emotional approach to this decision.
The mathematical approach
The mathematical approach would be to do what makes the most sense financially. Go with the decision that will save you more or cost you less money.
If, for instance, you have zero-interest debt, then focusing on saving money makes perfect sense. One example of this kind of scenario is provided by credit cards that provide 0% interest on purchases for a period ranging from one to two years.
It is a legitimate argument to suggest that you should take advantage of interest-free borrowing for the most extended period feasible, provided that you have the cash to pay off the debt before the interest expenses kick in. That extra money could then be saved or, better yet, invested to increase its value over time.
On the other hand, if the interest you will earn on your savings is higher than the interest you need to pay on the debt, then mathematically, it would make sense to prioritise paying down debt over savings.
The emotional approach
Put simply, with the emotional approach, you’re leading with your heart and not your head. Your decision here is based on what feels right for you.
If you have debt keeping you up at night and you feel overwhelmed by the financial burden, you may decide paying down the debt is the best option for you, even if it’s low-interest debt.
For this reason, over 45,000 students in the UK overpaid their student loans during the 2020/21 tax year, rather than only making the standard minimum payment that comes out of their monthly paycheque like tax.
While they could potentially save or invest the money to make it grow, they prefer having the satisfaction of not being indebted to anyone.
The best of both worlds
If you can’t decide between the two approaches with your money, you don’t have to. You could consider a more balanced approach to financial planning, which would allow you to pay off your debts while building savings.
After creating a budget and setting your financial priorities, determine if you have enough money to get you through a financial emergency, such as an illness or a job loss.
Determine how much money you’ll need for food, clothing, entertainment, and other fixed and variable costs by keeping track of your spending for a month. As long as you have saved three months’ expenses, your finances are sound; you can then focus on paying off debt.
No matter whatever path you choose, it’s crucial that your personal financial goals are weighed and prioritised before deciding. Balance is vital when determining whether to pay off your debt or save for the future.