Should I save, or pay off debt?

Saving money may seem like the sensible thing to do – but if you have debt, it may not be your best option.

Today, debt is everywhere. At the last count, households in the UK had £1.28 trillion (yes, trillion) of debt ^{Footnote [1]}. Debt comes in the obvious forms of credit cards and overdrafts. But it’s also in the form of things we consider pretty commonplace – things like mortgages and student loans. Debts we need to further our education or to build a life. 

“To view all borrowing as bad is unfair,” says Aviva’s Head of Savings and Retirement, Alistair McQueen. “Borrowing, and its repayment, helps us spread our expenditure over time.”

It’s a mindset that can be hard to understand. Since childhood, we’re brought up to think that saving money is important. Having three months’ worth of money stowed away to help if you suddenly lose your income, or need to cover a big household repair, is undeniably a good idea. But if you’ve got high-interest, short-term debts? Prioritising your savings isn’t always the best thing to do.

Let’s face it: borrowing money isn’t free. When it comes to short-term debts like credit cards or personal loans, you’ll often end up paying more interest each month than you would earn from a savings account. 

If you’ve got a pot of savings stowed away, check how much interest you’re getting from it. Now look at how much interest you’re paying on your short-term debts. If the debt interest outweighs the savings interest, it’s a no-brainer: use at least some of your savings to clear your debts. Otherwise, you’re paying out more in the long run. 

Once you clear the debt, you can then use the money you were paying it off with to build your savings back up again.

If you’ve got more than one source of debt, deciding which one to tackle first can be overwhelming. Alistair suggests taking a step back and looking at the bigger picture. 

“When considering which debts to repay, first write down how much you’re borrowing, from who, and the monthly cost of each sum borrowed,” he says. “Then, it typically makes good sense to repay the most expensive sum first – that is, the one that carries the highest monthly charge, or interest payment.” 

Whatever debt you decide to focus on first, remember you might still need to make at least the minimum payments on your other debts.

There may well be a time when you need to access funds in an emergency. But good financial planning isn’t always about having piles of money: it’s about having the means to access that money. So, if you’re paying off debt at the moment instead of saving, it could be a good idea to make sure you’ve got access to a 0% interest credit card with a high enough credit limit to cover three months’ outgoings.

There are some debts it's often not worth rushing to repay. Take student loans based on current rules, they don’t count against you in a credit check. They're also unlike other loans as there's arguably less pressure to actually pay it off. In fact, depending on when you took out the loan,any remaining debt will be wiped once you turn 65,or 25 or 30 years after you are earning enough to begin repaying. In terms of repayment, you contribute 9% of your earnings once you earn above a certain threshold [the exact amount is linked to when you took out the loan). So the amount you owe doesn't necessarily affect the amount you pay back. Bizarre, but true. (Source of evidence: https://www.gov.uk/government/news/8-things-you-should-know-about-your-student-loan--2)

It also doesn't make sense to repay debts you'll be charged a penalty fee on -things like a mortgage ,or some personal loans. If you find yourself in the fortunate position of being able to repay such debts early ,it might be better to put the money into a savings account until the repayment charge gets small enough or goes away.

That's not to say you shouldn't make early repayments to your mortgage to bring down the overall sum. But only do it if you've got no other debts, the interest you'll save on your mortgage is more than you'd earn from savings, and you won't trigger an early repayment fee.

While debts like mortgages and student loans are often an unavoidable part of life, it could be possible to reduce your short-term debts. You just need to up your budgeting game. 

If you find you’re using expensive short-term borrowing, such as credit cards, to fund your regular lifestyle, it’s possible that you’re living beyond your means. “This is a very expensive way to fund your life, and can easily spiral out of control,” says Alistair. “Begin by getting these loans under control. And if you’re unsure how, there are many agencies available to help – such as the charity Step Change.” 

Got your short-term debts cleared and your budgeting plan in place? There are so many savings options that it can be hard to know where to start. To understand what’s available to you, spend time researching options online or speak to your bank about what they can offer. If you still can’t find the answers you need, you can also speak to an Independent Financial Adviser, but they’ll charge you for their services.

If you’re not a risk-taker cash savings accounts are an obvious starting point. Sign up for free to Aviva Save, our savings account marketplace, and you’ll get access to a selection of accounts from banks across the UK. 

Want to take a bit more risk? If you’re in a position to put some money away for a few years, a stocks and shares ISA is worth looking into. You can invest up to £20,000 tax-efficiently each tax year. Though, tax treatment depends on individual circumstances and may be subject to change in future. With a Stocks and Shares ISA your money can be invested in the stock market. So, any profit you make depends on how the market performs – which, as with all investments, has the potential to go down as well as up and you may get back less than you invested.