When it comes to managing your money, one of the biggest dilemmas people face is deciding whether to pay off debt or focus on building savings. Both are crucial steps toward financial stability, but prioritising one over the other can feel like walking a tightrope.
The answer isn’t one-size-fits-all, as it it depends on your individual circumstances, the type of debt you have, and your financial goals. Let’s take a closer look.
The Case for Paying Off Debt First
Debt, especially high-interest debt like credit cards or payday loans, can weigh heavily on your finances. The longer you carry it, the more you pay in interest, which makes it harder to get ahead. Putting debt repayment at the forefront can free up money that would otherwise go toward interest payments, giving you more breathing room in the long run.
Take credit cards as an example. The average interest rate in the UK hovers around 20%, meaning that for every £1,000 of unpaid debt, you’re paying £200 a year in interest alone. Paying down high-interest debt as quickly as possible often makes more financial sense than saving because the return on paying off debt is effectively the interest rate you’re avoiding.
Of course, debt repayment also brings peace of mind. Owing money can be stressful, and reducing or eliminating it can feel like lifting a weight off your shoulders. For some, the emotional benefit of being debt-free outweighs any potential gains from saving.
Why You Might Save First
Saving money, particularly an emergency fund, provides a financial safety net. Life is unpredictable, and having a cushion to fall back on can prevent small setbacks from turning into major crises. If you don’t have any savings and an unexpected expense arises—a car repair, a medical bill, or even a job loss—you might find yourself relying on credit again, plunging deeper into debt.
Financial experts typically recommend setting aside at least three to six months’ worth of essential expenses in an emergency fund. Even starting with £500 can make a huge difference. This fund acts as a buffer, giving you time to recover from unexpected challenges without resorting to borrowing.
Another reason to save first is if your debt has relatively low interest rates. For example, student loans or a mortgage often come with lower rates, and in some cases, they may even be tax-deductible. In these situations, you might prioritise building up your savings while making regular payments on the debt.
Finding a Balance: The Best of Both Worlds
For many, the best approach is a hybrid strategy: paying down debt while simultaneously saving. This ensures you’re reducing your liabilities without leaving yourself vulnerable to financial emergencies.
Start by building a small emergency fund, ideally £500 to £1,000, while making minimum payments on all your debts. Once that safety net is in place, shift your focus to tackling high-interest debt aggressively. The “debt snowball” or “debt avalanche” methods can be effective strategies:
- Debt Snowball: Pay off your smallest debts first while making minimum payments on larger ones. The quick wins can motivate you to keep going.
- Debt Avalanche: Focus on the debts with the highest interest rates first to save the most money in the long term.
After addressing high-interest debt, you can balance paying down remaining debt with contributing more to your savings or investments. This balanced approach allows you to make progress on both fronts without neglecting one.
Other Factors to Consider
- Employer Match: If your workplace pension plan offers a match for your contributions, it’s often worth contributing enough to take full advantage. This is essentially free money and can have a significant impact on your long-term savings.
- Interest Rate Comparison: Compare the interest rate on your debt with the potential return on savings or investments. If your debt’s interest rate is higher than what you could earn in a savings account or through investments, prioritising debt repayment usually makes more sense.
- Your Personal Goals: Consider what matters most to you. If owning a home, starting a family, or retiring early is a top priority, your strategy should align with those goals.
The Bottom Line
There is no definitive answer to whether you should pay off debt or save first. The decision really depends on your financial situation, the type of debt you have, and your long-term goals. If your debt carries high interest rates, tackling it aggressively is often the smartest move. On the other hand, having some savings in place is crucial for handling life’s curveballs without falling deeper into debt.
For most people, a balanced approach works best. 1. build a small emergency fund, tackle high-interest debt, and then 2. work toward a larger savings goal while continuing to chip away at other debts. If you take thoughtful, deliberate steps, you’ll be well on your way to financial freedom.
