I have talked about the importance of having a budget and clearly defining the goals for which you are reducing your expenses. You will be able to save money by following a budget, but you will have many ways to use the extra money. Two of the most common ways to use that money is to build your savings or to repay your debt. But which one is a better option?
People usually have huge debts but very little savings. Choosing one over the other requires some analysis of what will be financially better in the long run. I believe, in most cases, it is better to use the money to repay your debt, as there are huge costs associated with any debt such as interest rates and late payment fees. Savings would give you a profit as you’ll earn a return on your investment, but it will not match the costs of your debts. The only exception to this rule is when you have debt at very low fixed interest rates and you are able to earn more from your savings.
If you are boosting your savings and ignoring your huge credit card or other debts, then you would lose out in the long run. When you stay under the burden of debt for a longer time by making minimum payments on your credit card, the total interest you end up paying by revolving your debt would be much more than you can ever earn from your savings.
This means, in spite of having significant savings, your financial condition will be worse as your liabilities will grow much faster than your assets. In the end, you’ll have to resort to spending your savings to repay your huge debt, so your strategy of preferring savings to debt repayment will be futile. It’ll be even worse if you end up missing a payment because your credit score will take a hit, which will increase your cost for future loans.
So my advice is that you should always repay your debt right now instead of directing the money towards your savings. After you have repaid the debt, you can start building your savings with no worries about defaulting on the loan or having to pay a lot of interest.
Moreover, it’ll be much easier to focus on building your savings when you don’t have any debt pressure. With a freedom to lock your funds in long term investments, you’ll also be able to earn better returns.