Part of your savings plan may involve paying off debts while saving money for future use. But, which one should you prioritise if you have a limited budget to work with? The key lies in understanding the benefits of each so that you can fine-tune your strategy and attain good financial health.
Advantages of Paying Off Debt
Debts may refer to loans, credit card and utility bills, or financial favors that you receive from family or friends. Debt is classified either as secured or unsecured. Secured debt involves pledging an asset as collateral for the loan, like your house or car. On the other hand, unsecured debt like credit card debt does not involve any collateral, but the payoffs are higher, too.
Depending on how much debt you have and how you manage it, debt can be a useful financial tool. Obviously, borrowing money to serve a legitimate financial need isn’t the same as when you spend the borrowed money on unnecessary expenses.
Here are a couple of ways that paying off debt as soon as possible can help you financially:
- Interest fees decrease over time. This is true, especially for credit card debt, where interest is computed on your total purchases. If you’re unable to lower the outstanding credit, you might find yourself in a cycle of making payments that mostly go toward interest fees and not make significant reductions in your total debt.
- Your credit score improves. Banks and other money lending institutions keep records of your credit history, and failure to settle your loans can lower your credit score. Credit scores are important because they can unlock many savings and rewards like more leniency on various types of financial transactions.
Apart from these benefits, paying off debt can be empowering for yourself. Getting rid of it frees you from distress and inspires you to achieve your saving goals.
Advantages of Saving Money
Saving money is, of course, one of the most important aspects of good financial management. Ideally, your savings fund should cover six months’ worth of living expenses in case of unforeseen circumstances like a sudden illness, work retrenchment, or loss of property due to natural disasters. Proper budgeting methods and techniques can help you use your money wisely and set aside savings, too.
Building your savings fund is beneficial in several different ways:
- It allows you to leverage the value of compounding interest. Here’s how compounding interest works: You first earn interest on the principal amount of your savings and then continue to do so as interest is now computed based on your savings balance plus any interest it has previously earned.
As such, you should start saving sooner rather than later to take advantage of compounding interest.
- You can go into investment sooner, too. When you have your funds ready, you can immediately learn stock trading or other ways of investing to grow your money even more. You don’t have to wait until you’ve fully repaid your debt before you can take advantage of investment opportunities.
- Your savings can help you avoid taking out new loans so that you don’t go deeper into debt. Even if unexpected expenses occur, you can pull yourself out of the situation without causing serious damage to your finances.
The Bottom Line
Being in debt can cost you more money in the long run, so having a clean slate in the earliest possible time should be your goal. At the same time, you shouldn’t wait to get started on saving either. While it takes a lot of work to decide whether you should first save money or pay off debts, the one definitive rule to keep in mind is to use your money wisely. This way, you can do both and reap the benefits that each strategy offers.
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Edited by Temitope Adelekan