Pay off debts early or save money: which is more important?

2024 Author: Malcolm Clapton | [email protected]. Last modified: 2023-12-17 03:44

Repaying a loan and saving money at the same time - practice shows that this is unrealistic. Then which of these directions should you give preference to? Experts say that it is much more profitable to repay the loan as soon as possible. Why? Find out from this article.

According to VTsIOM, the share of respondents with savings in Russia has remained practically unchanged over the past years - no more than 34%. At the same time, more than half (57%) of the respondents admit that they are not going to save money in the near future.

Despite the fact that an earlier sociological study (2009) showed: 26% of Russians have an outstanding loan. Almost every fifth (21%) loan payments make up half or even most of their income.

This situation is developing not only in Russia. According to the Federal Reserve Bank of St. Louis (one of the 12 banks that make up the US Federal Reserve System), the percentage of personal savings in the US is only 4.2%.

This is a big problem. Considering that most financial advisors say you need to set aside 10 to 20% of your income. Some experts argue that if you have a double sword of Damocles hanging over you in the form of high-interest debt and lack of savings, in the long term, the best option is to invest all your money in paying off high-interest debt. Is it so? Let's try to figure it out.

Savings through savings on interest

Trying to save money while you have high interest debt is like trying to float with an anchor tied to your leg.

Unsurprisingly, people with large monthly loan bills have very little money left to save.

According to a Wells Fargo Retirement survey, more than half of respondents cite their credit obligations as the “biggest financial problem” in their lives. Of those who said that they were unable to save money, 87% said that the reason was simply not enough money, and 81% explained this by the fact that they first want to pay off the loan.

Imagine a person with a loan of 550,000 rubles. at 20% per annum for 5 years. If his minimum monthly payment is 9,000 rubles. from the principal amount of the debt plus interest (on average, the first year of payments) 8,000 rubles, he will pay about 17,000 rubles a month. RUB 8,000 - this is the bank's profit in the form of interest.

If this person pays with minimal payments all the time, it will take him 5 years to pay off the debt. During this time, he will additionally overpay more than 270,000 rubles in the form of interest.

Paying off your debt should be a priority. This is more important than personal savings because it has a much greater impact on the future. Especially when it comes to loan debt.

However, before starting to pay off the debt in "large chunks", that is, in amounts exceeding the minimum monthly payment, it is rational to make small savings.

Most financial advisors recommend saving 3 to 6 monthly amounts that you spend on living expenses. So to speak, "for a rainy day."

As long as you have emergency supplies, you are at least not multiplying your debt. Have a little savings, but your main goal should be to pay off your debt.

Guaranteed return

The biggest plus of early repayment of debt on a loan is a guaranteed return of interest in case of early repayment.

Using the interest rate, balance and payment rate, you can calculate and know exactly the guaranteed percentage of return.

If you are lucky enough to receive a 2% certificate of deposit, then the return on early loan repayment will be 15% - this is a very good deal.

By investing more money in early repayment of the loan, you will not only get out of it earlier, but also save a huge amount of money from interest.

If you can't save now, because the loan is "pulling", then later you will be able to save without any problems.

The problem is that many banks by the terms of the loan agreement prohibit the payment of amounts in excess of the amounts indicated in the loan repayment schedule. Only some loan programs provide for the possibility of early monthly debt repayment. As a rule, only full early repayment of the loan is encouraged. It is necessary to carefully study the terms of lending.

The sooner you pay off the debt, the more you will save on interest and the more you can save in the future.

When you are out of debt, you have more "freedom" in planning your monthly budget - you can save.

What if there is no money to pay off the loan ahead of schedule?

Experts offer a variety of options. Some advise to save money, others - to look for another loan offer with a lower interest rate. In the latter case, the main thing is not to "tarnish" the credit history.

From a financial point of view, the most profitable is the first repayment of the loan with the highest interest rate. This will save more money.

But there is an opinion that it is better to start with the "smallest" loan, since paying off at least one debt gives you psychological confidence that you can put things in order in your finances.

Do what you have to, get out of debt. Focus on the long term, not the desires of the moment. It takes discipline, but ultimately gives you more freedom. The absence of debt allows you to accumulate funds.