Watch this video - Should you save or pay off debts? - from the Money Advice Service.
If you are paying more for your borrowing than you are getting on your savings, then it makes sense to pay off your loans - so long as you can access funds in an emergency (see more on this below) and provided you will not incur high penalties for repaying your loan.
Once you've cleared your debts you are freed up to save more and faster.
If you have several debts to clear, aim to clear the most expensive ones first. These are the most common examples.
- Most credit card debt.
- Store card debts
- Unauthorised overdraft
- Catalogue shopping
- Payday loans
- Door-to-door lending (home credit)
Money fitness tip
Clear your debts with the highest interest charges first, so you're in a better position to start saving.
When to start saving
Generally it's fine to save and have some debt as long as:
- You're keeping up with your mortgage payments
- You're paying off your credit card bill each month
- You don't have other loans or credit commitments that are costing you more in interest than you could earn on your savings
Get into the savings habit
Regular saving is really important. Make it easy by setting up a standing order or Direct Debit to move money into a savings account regularly so you don't spend it or forget to put it aside. After a while, you won’t even miss it. And, to save even faster, why not set a savings goal so you know:
- How much you are going to save
- How long it will take you to reach your goal
If you pay tax you'll probably want to start by thinking about tax efficient savings, like making the most of your ISA allowance. See Goal setting for how to get started.
The Personal Savings Allowance
From April 2016 you are entitled to a Personal Savings Allowance. This means you won’t pay tax on the first £1,000 of interest you earn from savings (or on the first £500 if you’re a higher rate taxpayer). Find out more about the Personal Savings Allowance.
What about paying off your mortgage early?
If you have cash to spare you might wonder about reducing your mortgage if you have one.
What about an emergency fund?
Ideally you should aim to have three months' money in reserve as part of your savings – see Saving for emergencies. However, if you have debts use the money to clear these first provided you have access to emergency funds such as a credit card. However, if an emergency arises and you have to you go for this option, it’s important not to start using the card for other purchases, as you will risk running up yet more debt.