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Should you save, or pay off credit card debt and loans?

If you have credit card, store card or personal loan debt, you may have wondered whether it is worth using your savings to pay off this debt. However, you may like the safety net of a savings pot, even if you are paying interest on your credit card or loan debt.

But, is it worth using your savings to pay off your debt? Keep reading to find out.

Using savings to pay debt

If you have savings and debts, the chances are that you are not managing your cash efficiently. In general terms, you should always use your savings to repay your debt as it will leave you better off.

Here’s a simple example:

If you have a £2,000 credit card balance at a rate of 16 per cent, you’ll pay £320 in interest every year.

If you have £2,000 in a savings account earning a rate of 4 per cent, you’ll earn £80 in interest every year.

So, in this situation, if you used your savings to pay off your debt, you would be £240 a year better off.

You will find that most of your debts will charge a higher rate of interest than you can earn on even the best savings accounts. The Daily Telegraph recently reported that ‘about two thirds of the major store cards on the market charge more than 25 per cent interest’ while recent Bank of England figures show that the average credit card rate in the UK is 17.3 per cent.

If you compare this to the very best savings rates – around 5 or 6 per cent – you will see that you’ll invariably end up paying more in interest charges on debts than you will earn in savings interest. This is why it can pay to repay your debts with your savings.

Two reasons you may not use your savings to pay off your debts

While it will generally pay to repay your credit card and loan debts with your savings, there are a couple of exceptions to this rule:

  • Where there are penalties – If you will be penalised for repaying your debt – for example you’ll face a penalty if you pay a loan off early – then it may be better keeping your savings. You can then pay off the debt when there is no longer a penalty for doing so
  • Where you have cheap debt – If you have carefully managed your debt and you are benefiting from very low interest rates then you may actually make more money from your savings. For example, if your credit card balance is on a 0 per cent deal, you will actually be better off earning interest on your savings than paying off your low cost debt

Shouldn’t I have some savings?

Many people like the safety net of a savings pot that they can use in the event of an emergency. So, isn’t it worth keeping some savings for a rainy day?

Well, many experts say ‘no’. Money expert Martin Lewis says that ‘for anyone with expensive debts – particularly on credit cards – it's silly.’ Paying off your debts with your savings will generally save you money.

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