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Pay off debt or save?

Tuesday, November 1, 2011
Should you pay off debt or save?
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Article from 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, such as hire purchase or credit card debt. This is because you usually pay more interest on a loan than the interest you earn on savings (after tax).

However, there are some cases where 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 into 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.

Read more about KiwiSaver here

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.

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

From April 2013 the minimum worker contribution and compulsory employer contributions will rise from the current two per cent to three per cent.

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 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.

SortedArticle provided by Sorted.org.nz. The Retirement Commission's free and independent website Sorted.org.nz is packed with helpful information, tools and calculators to help you manage your personal finances.

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