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Pay Off Debt Or Save?

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Sorted.org.nz
Sorted.org.nz

Should you pay off your debt faster or start saving now? As a rule, it makes sense to try to pay back your loans as fast as possible before you start saving – particularly if you have high interest debt like hire purchase or credit cards. This is because usually you pay more interest on a loan than the interest you earn on savings (after tax).

However, there are some cases when it’s good to do both – pay off debt fast and save at the same time.

Consolidate your debts and save money

Credit cards have higher interest than mortgages – perhaps more than twice as much! Think about consolidating your debts onto a lower interest mortgage.

Joining KiwiSaver

Even if you have debt, you may be better off financially joining the government’s new KiwiSaver retirement savings scheme because of the incentives – including a $1,000 ‘kick start’ to your savings and up to $1040 annual tax credits. Find out more…

Workplace saving

Some employers offer their own subsidised retirement savings schemes. This means that for every amount you save, your employer also contributes some money. Check out the Sorted.org.nz At work section for more details

You may be better off paying into a scheme like this, as well as repaying your mortgage or other loan faster.

Employer contributions to KiwiSaver will be compulsory from April 2008 – starting off at 1% and rising to 4% by April 2011.

Saving for an emergency fund

It's common sense to have an amount of money (say two or three months' income) you can call on if the unexpected happens. It means you won't have to borrow money or be left financially vulnerable.

Saving for an emergency fund makes sense even if you're paying off a mortgage, but may not be such a good option if you've got high interest debt.

Getting into the savings habit

If you would like to get into the savings habit, you could consider starting a small retirement savings scheme while you are still paying off a loan (such as your mortgage).

You'll get into the habit of saving, and start to build a small nest egg. You'll also start to build your knowledge of savings and investment options, so that you're better prepared when you want to start serious saving.

Warning - the dangers of renewing or extending debt

While it might be good financial logic to pay off your mortgage before you start serious saving, some people fall into the mortgage trap and never start saving. Beware the following pitfalls:

  • You take your time about paying off the mortgage and don't leave yourself enough years to save before retirement. Remember - you probably need at least 10 - 20 years to save enough for your retirement.
  • You pay off the mortgage and then decided to buy a more expensive home - which results in a new mortgage and still no savings.
  • You're tempted to take on a higher mortgage than you could afford if you took into account your savings goals. Your new higher mortgage repayments reduce your ability to save.

 

Content provided by Sorted.org.nz, Your Independent Money Guide.

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