So you’ve already got your budget together and now you can see you have some spare money. (That’s after you’ve already covered any debt repayments in your general expenses – whether they’re a personal loan or a home loan.) What’s the best option for your spare cash – save it for that overseas holiday you’ve been dreaming about, invest it to make more money on it, or get your debts cleared sooner?
Debt versus savings – what’s best for you?
In simple cases, deciding whether to put your money in a savings account where it can earn you more money or reduce your current debt can be as easy as comparing the interest rate that you could earn from a savings account or term deposit to the interest rate that your debt is costing you.
It’s not always that straightforward, though. For starters, interest rates can change (especially if you’ve borrowed at a special short-term rate). It also depends on the type of debt you have.
In terms of interest, regular credit card debt can be one of the costliest types – rates can easily reach 20% per annum or higher. If you’re not paying your credit card balance off in full each month, clearing this debt should be a priority to avoid interest charges building up.
Making just the minimum payment amount each month can be useful for short periods to give you some flexibility, but your interest charges will be building and you probably won’t be reducing your total balance. It’s good to know how making your credit card’s minimum payment affects your total balance.
If you can, paying the balance in full in the next month or two is your best option. But if your debt is too much for that to be realistic, it’s important to have a plan to reduce your balance. You might work out a savings plan to reduce it over several months or maybe you know that you will have some extra money coming in to pay off your whole balance at once, like a tax return or an annual bonus.
Another option could be transferring your balance to a lower rate card – find out more about changing your credit card to suit your needs. Or maybe a debt consolidation loan could be a better option to help reduce your interest charges.
Once you’ve found out which is the best option, get a savings plan together to reach your target of paying your credit card debt off as soon as possible.
Personal loan interest rates usually fall somewhere between credit cards and home loans. Unlike a credit card, your personal loan repayment schedule (that’s your minimum weekly or monthly repayments) are structured to clear your debt in a relatively efficient way. It also has a definite end date – although extra repayments will obviously end your loan sooner. If you don’t know when your loan is scheduled to end, check with your bank.
You might decide that your current schedule is OK and that you’d rather put your extra money away for something else, like a new couch or TV. But it’s good to know exactly what your choices cost you, so have a look at what extra repayments could save you. Get your loan details ready and use this loan repayment calculator to do the sums easily. The savings in interest could be worth more to you in the long run.
If you have a home loan, talk with your bank (or lender) about shifting your personal loan debt into your home loan. Consolidating your debt like this can reduce the amount of your personal loan repayment, but keep in mind that by spreading your repayments out over a longer period of time (the term of your home loan), you could end up spending a larger total amount on interest.
To make this option work for you, make sure you increase your home loan payments by the amount you were paying regularly into your personal loan. For example, if you had a personal loan of $10,000 and your weekly repayments for it were $35 a week, then you transfer the personal loan balance to your home loan and increase your home loan payments by $35 a week, you could end up saving on interest.
Home loan rates are generally lower interest rates compared to other types of debt, but are over a longer period. Because home loans are long term, you might not want to put every extra dollar you have towards it. But check all your options first – find out what repaying a bit extra on your home loan now would be worth later, then decide whether to use your extra money to save for something else.
There are a couple of options:
- Add an extra amount to your regular home loan repayments. This can reduce the length of your loan and save on interest. To see what you could save, get your loan details ready (loan amount, current interest rate, loan term and your current payment amounts) then use this easy repayments calculator.
- Make a lump sum repayment – this Lump sum repayment caculator will work out your potential savings based on the lump sum you have.
If you have a variable rate home loan and have extra money to put towards it, find out how your everyday bank account can reduce your home loan interest through 100% offset. Compare these savings towhat you could save by making extra repayments.
Fixed rate home loans usually have a limit on the amount of extra money you can repay before other costs apply. These can get expensive, so check with your bank or read your terms and conditions. Find out what these costs are by reading understanding your home loan’s economic cost. You might decide to repay as much you can, then save the rest until the end of your fixed rate term and make a lump sum repayment then.
If you don’t want to put your savings towards your debt
Maybe you’ll decide that you’re happy with your current debt level and repayments, and that there’s some extra spending you’d rather save for. For example you might be paying off a car over seven years when you get a pay rise. Maybe your choice will be to put your extra money towards a holiday rather than paying off your car sooner. That’s not necessarily a bad thing, but make sure that you know what you’re missing out on in terms of saving on interest charges.
Whatever you decide to do with your spare money, make a clear plan to get your savings together – it will help you stay on track and reach your goals.