What is a Debt Relief Order and how does it work?
Find out which debt solution is right for youGet started
Answer a few simple questions
See if you are suitable
Understand your next steps
If you have savings should you use them to pay off your credit card debts?
The issue of whether you should save or pay off your credit card debts is not a simple one. There are, after all, experts who say you should always have savings available as a ‘rainy day’ fund. Which most people would agree is a good idea. But what if your washing machine breaks down and you need to get another? Or your boiler goes on the blink?
How much you should have saved is also up for debate. A good rule of thumb is that you should have at least three months’ salary saved up in reserve, just in case you fall ill, or lose your job, or are unable to work for some other reason. This money would be what you’d use to tide you over the out-of-work period. Sensible enough idea.
But what if you’ve also got debts, especially high-interest debts, should you not pay those off first, before saving anything?
It’s a tough question, but once we’ve looked at it in more detail, you’ll soon see that paying off your high interest debts first is definitely the best idea.
High Interest debts
So, the first thing you need to do is find out which of your debts has the highest rate of interest. The details of the rates of interest should be on the terms and conditions leaflet you received when you applied for the card (or other form of credit). If you can’t find it, a simple call to the company should give you the information you need.
Next you need to find out what balances remain on each card. You can find this information by checking your monthly statements, looking at your account online or calling the lender directly. Once you know this you can prioritise your debts in order of what’s going to cost you the most in the long term.
Now, before we go any further, there are a couple of things you might like to think about, before deciding to dip into your savings.
Switch and Save
You could find another way out of high interest debt, without touching your savings, by switching your current high interest debt on to a new balance transfer or money transfer card with 0% interest. But, you need to think carefully about this, as there are usually some fees involved and you’ll have to keep a note of when the interest-free period ends, so that you can try to clear the balance in full by that time. Bear in mind too that if you fail to make one of your monthly payments on time, or pay less than the minimum you may lose the 0% deal and be charged interest on the whole balance.
At the time of writing, Uswitch show numerous cards with between 23-40 months interest free, and an average interest rate of 18.9% after the free period has ended. The main difference between the cards is the transfer fee. They range from 0%, for the cards offering only 23 months interest free, to 2.95% for the 40 month interest free deal. So it’s worth working out how long you think you’ll realistically need to pay off your balance and then choose the card that best suits your needs.
It’s also worth remembering that when you apply for a credit card, the lender will check your credit history. So, if yours is not that great, maybe you’ve missed some payments in the past, you may find that the lender rejects your application. If this rules out applying for a credit card, there are some other options.
You could just shuffle your balances around on the current cards you have, which means you don’t have to apply for any new ones. Just choose the card with the lowest interest rate, check you have the balance amount available and transfer it all to that card.
Could you borrow from friends and family?
Another way to pay off your higher interest debts, without touching your savings is to ask if any family or friends are willing to give you a loan. You don’t have to ask them to give it to you interest free, but it would be great if they agreed to lend you the money at a rate that’s much less than your lender is adding.
It might not be an option
There is an exception to the rule though. This is when it’s so expensive for you to pay off the debt, it wouldn’t be worth it for you. This can happen when there are penalties for paying off what you owe early. If this is the case, it may be worth you leaving your savings where they are until the penalty becomes so small you don’t need to worry about it anymore.
If neither of these is a viable option…
If neither of these options is viable for you, it’s time to think about using your savings to pay off what you currently owe. Why is this a better idea than continuing to pay your debts and keep your savings? Because it’s nearly always going to cost you more to borrow money from a lender than they’ll give you for saving. When you save, your bank lends out the money you deposit to others at a much higher rate of interest than they give you on the saving. The difference between the two is the banks profit.
Here’s an example of what we mean, it’s easier to see if we do it like this:
If you have £1,000 on your credit card with an APR of 20%, you’ll pay £200 over the course of the year.
If you have £1,000 in a savings account that pays you 1.65% after tax (which is the best rate we could find for instant access savings at the time of writing) then you’ll earn just £16.50 of interest on it.
So, if you use the savings to pay off your credit card balance you’ll save yourself £183.50 over the course of a year. So it makes good sense to use your savings to clear your debt, then think about saving up again.
And, what about that rainy day fund for emergencies?
If you’re one of those people who fret if you don’t have a safety net, it may be really tempting to squirrel money away. Don’t – it’s always better to pay off your high interest debts than save. And, who knows, your rainy day find could just sit there for years without being needed. If this happens, you’ll kick yourself if you’ve been paying years of expensive interest.
However, this doesn’t means that you can’t save for things in the future that you know are going to happen, and cost you money, like Christmas. As with all things in life, it's about balance and you need to find an approach that you feel comfortable with.
We hope this has helped you make up your mind to pay off your high interest debts with your savings. However, if you feel like you need more help with managing your debts, please do speak to one of our trained debt advisors – we’re here to help! Just choose one of the ‘contact us’ options on the left to get started.
by Shelley BowersBack to blog home