Is it better to save money or pay down debt?

Getting into debt is a horrible experience. Sleepless nights and continual stress take their emotional and physical toll. 

Dramatic lifestyle changes are usually needed to get back on the straight and narrow. However, when you finally pull yourself out of that debt hole, it feels as if you can conquer the world. 

Most people have debt. Mortgages, credit cards and overdrafts are not usually seen as debt, but they are borrowings all the same. If you fail to meet repayments on these borrowings, you’ll find yourself in a battle with creditors. 

The best way to ensure you don’t find yourself in court over an unpaid legal bill is to build up your savings, constructing a savings buffer to ensure that even if you find yourself without a regular income, you can still meet debt repayments. 

This leads to another question: is it better to save money or pay down debt? 

Save money or pay debt

Not all debt is bad. Some debt such as mortgages and businesses loans can improve your finances significantly over time. What’s more, if you’re savvy, by taking advantage of 0% interest rates on credit cards you can consolidate loans and pay off other creditors. Most credit card companies also offer reward points, which can add up over time and help improve your wellbeing by reducing the cost of holidays, shopping or eating out. 

So, some borrowing can be beneficial to your wealth. But even with these types of credit, it pays to have some savings to tide you over for a rainy day. 

Ultimately, whether you pay down debt or saves depends on your financial position. 

Do what’s best for you

If you’re deep in debt, it’s best to pay off your borrowings first to a level that’s sustainable before starting to build a savings buffer. Pay off debt with the highest interest rate first. The great things about paying debt down is that it compounds over time.  The more you pay off, the faster your debt will fall.  

If you’re not drowning in debt, borrowing to take advantage of special offers may be suitable but beware, you should make sure you only borrow as much as you can afford. That new car can wait, and you should never borrow to invest. 

The bottom line 

If you do borrow to take advantage of credit card offers or purchase a house, a savings buffer will be useful. A basket of high dividend-paying shares in an ISA could be the best way to manage this cash cushion. The ISA wrapper means no tax is paid on the dividends received and with dividend champions such as Royal Dutch Shell currently supporting yields of 7%, the income on offer is significantly more than any savings account offers. 

All in all, if you’re drowning in debt, it’s best to pay your debt down before you start saving. However, if your financial position is stable, favouring saving over debt might be the better option. 

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Rupert Hargreaves owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.