Should i pay off debt? The simple answer is yes. We look at what is involved.
Banks Love Debt
Debts usually cost more than savings earn. Cancel them out and you’re better off.
Simply put, by saving money you are actually lending your money to the bank so that it can lend it to others. Its profit is the difference between the rate it charges other people (the borrowing rate) and the rate it borrows money from you (the savings rate). Overall, borrowing will always be more expensive than the returns from saving.
Because of this, I find it incredibly annoying that so many people have loans and savings accounts open at the same time, frequently with the same bank. In essence, the bank is returning the funds you lent it while charging you significantly more.
Should I Pay Off Debt? Exceptions to The Rule
The rule is based on the observation that, in most cases, the cost of debt outweighs the advantage of savings. Therefore, paying off debt is better for your wallet than starting to save. The few instances in which debts are less expensive than savings or require so much money to repay that it is not worthwhile are the exceptions:
The Penalty Exception
Leave the money in a savings account until the penalty is so minimal that it won’t matter if you’re trapped into the obligation and paying it off will result in a penalty, as with some loans or mortgages.
Interest-Free/Cheap Debt Exception
If the interest rate on your loan is lower than the amount your savings yield after taxes, you can benefit from saving money and keep your debts as long as you are financially responsible. In essence, you are receiving interest payments on bank loans that you did not request.
Should I Pay Off Debt? The Importance Of Emergency Funds
Yes, in the simplest form. Generally speaking, it pays to have three to six months’ worth of costs saved up in case of necessity. for loans, mortgages, and other forms of fixed-repayment borrowing, for sure.
Credit cards are an exception, though. Many people will find what I’m about to say emotionally challenging. It feels comfortable to have some money set aside in saves, especially in light of the traditional budgeting advice to always have a “emergency cash fund.”
Although it is the right goal, there is a better solution if you have pricey credit card debt because you can borrow more without applying for a new product.
If you were to pay off your debt with savings, but keep your credit cards open in case of a serious emergency (and by serious emergency, we mean something like your roof caves in or you can’t feed the kids; not a new TV), it’s crucial to maintain the credit available.
Discipline
The prospect of using credit cards again could pose a considerable risk to those who are making a concentrated effort to pay off significant obligations. Although it is not a wise idea to create an emergency fund because there is no guarantee that you will ever need it, there are some reasons to make tiny savings preparations for certain upcoming occurrences.
For individuals who can’t trust themselves to stick to the credit card limit, saving a small amount each month for Christmas is an appropriate personal financial approach. However, restrict the quantity of money you give.
Although the gap between debt and savings in this situation is significantly lower, it is still preferable to use the funds to pay off your mortgage. Keep in mind that the aforementioned requires you have a top savings account, which sadly the majority of individuals do not.
