Debt before savings?

gavinchappell

Someone suggested to me the other day that the correct approach is always "debt before savings" so I've been thinking about my own approach. I currently have two forms of debt, my mortgage and a relatively small personal loan I took out to buy a car. I also have a credit card available, but currently empty.

At the moment, I'm paying the normal amount from my fixed rate mortgage, overpaying the loan slightly (about £30/month at the moment, but I intend to keep the payments the same every month so slowly my capital repayments will increase on that), and I'm also saving monthly towards my large known yearly bills (such as car insurance, maintenance, house insurance, Christmas, that sort of thing). So I suppose I have a sort of "hybrid" approach, I'm overpaying the loan with what I have spare while still saving.

However, would I be better off putting ALL my spare money onto the loan, and then when things like car insurance come around putting those onto my credit card and then going back to paying the minimum monthly payment on the loan while I settle the credit card?

To my mind, I would be better off being able to pay those bills straight off with money I have available in savings, but my credit card is currently around 1.3% lower interest-wise. Does this mean I'd be better off putting as much money as possible into the higher interest rate loan, even if that means loading my card up a few times a year? I'd be interested to hear other MoneySavers' opinions...

timbstoke

Personally, I take the approach that *flexible* debt should be paid off before trying to make any savings. That means cards, overdrafts, etc - things you can still spend on if you need to. If you have credit available, you don't need savings while you're paying it off. If the only debt you have is loans and other things that aren't easily flexible, then it makes sense to have a bit of cash available to fall back on rather than having to use a card.

What I'd do is have a 'cap' on savings while you're paying your loan - if your known expenses are £1000, cap your savings at £2000 - that leaves you plenty to deal with an emergency without having to touch your credit card, but once you hit the cap, all spare cash goes to the loan.

gavinchappell

Well this is the thing, the loan is via Zopa, so in terms of paying it off it's as flexible as a credit card (I can make as many overpayments as I like, whenever I like, with no penalties, just can't borrow more like I would with a card). I specifically chose that over a loan from my bank with the same interest rate for that reason, my bank would have only taken a full settlement rather than partial payments. I forgot to mention that I do also have a small overdraft, but this is relatively tiny and now only used as a "buffer" if the timings between some incoming and outgoing payments doesn't quite add up.

A cap is a good idea as well, although it's somewhat hard to predict what costs will be next year I could always budget for what things cost this year and work from there.

timbstoke

By flexible, I mean 'can spend it again if needed' rather than 'can make overpayments' :-) If you have credit card debt, there's no point having savings, because you can just eat back into the card if needed. If the only debt you have is loans, it makes more sense to have a bit of a buffer you can eat into before you start to build up interest-charging debt.

DebtGoneJohn

Personally, I think the way things are going now isn't a bad plan. Cap your savings at an amount you're comfortable with (I think around £2000 is about right) then i'd overpay like mad on the loan! Once the loans out of the way get onto your mortgage, if you can get that cleared you'll be in a great position in years to come!

I like the idea of capping your savings tho...I'll probably try this myself.

gavinchappell

Ahh, I see. Slightly different definitions of flexible there, oops!

I see what you're saying about having a buffer, although I'm wary that by doing that I'm then keeping my loan balance "artificially" high at 8.2%, and not getting not very much off the savings I'm putting aside (currently it's a shade over £500 in an ISA, 2% I think). Whereas by doing away with my savings for now, I could reduce the amount of 8.2% debt significantly, but may have to replace some of it with 6.9% debt temporarily later on and then when everything's paid off, I can really start building up my savings quickly again and once I've got a nice amount start overpaying my mortgage.

I think with the interest rates as they are it's going to be a bit swings and roundabouts which approach is better, so probably comes down to which one makes me "feel" more positive about the way I'm paying it off, which will then make that approach the easier one to stick to...

timbstoke

It's a judgment call. Worst case scenario is you have to hit your credit card if you need funds quickly, so hardly the end of the world. If the money's sitting there and you feel it's wasted, then by all means throw it at the loan.

climbgirl

Timbsroke is right, it's purely a judgement call. Obviously you will pay off the loan faster (and with less interest) if you have a lower amount of savings (or none at all).
But that depends on how comfortable you are with having no buffer - how secure is your job for example? Do you have access to credit cards etc for true emergencies?

It's up to you really!

gavinchappell

My job is more secure than most (it's public sector within a University, although I have a new job description on my desk which I'm supposed to sign, which I'm technically not qualified for so I've got a few admin errors to sort out!) and I do have a CC with a higher limit than I'd like (Barclays bumped it up even though I was nowhere near the original limit and I never got round to doing anything about it). So as far as a buffer goes, it's about as close to impossible as you can get for me to lose my job, and I do have access to emergency funds at a lower interest rate than my loan.

Obviously if my CC was a very high interest one at 15-16%+ then I wouldn't even be thinking about doing this as any savings I made paying off the original loan would be almost wiped out as soon as I went near the credit card due to lack of savings. But to my mind, with my card being cheaper than the loan it's almost like I can't lose whichever way I decide to play it. I would have just bought the car on the card but it was a private purchase and over my credit limit so not an option unless I had the limit extended further and used Paypal or similar. With hindsight, that's possibly what I should have done as even with fees I think it would have been cheaper than the loan, but it's done now so my priority is just to chip away at the loan as quickly as I can

Tixy

I'd have savings for things that you know are coming up - the presents, car insurance etc, in fact I wouldn't class these as savings but simply as budgeting pots.
And I wouldn't just count on the credit card for these types of things, its not unheard of for banks to drop limits or close cc accounts even for people in a good financial position, in fact it seems to be happening more.
I'd still keep the card for the totally unexpected/emergencies etc.

But I wouldn't start putting towards general savings in addition to the budgets whilst ever you have debt that you are being charged a higher APR than the savings could make.

Solstice_Twilight

My OH and I have a joint debt management plan, that is due to end in winter 2012. At the time that we started the plan, we had no savings whatsoever and the DMP budgets us down to the penny, which meant that we were stuck when we had an emergency (car needed repair; washing machine exploded; our cat became terminally ill and required us to make an insurance claim, which involved paying an excess). The DMP allows us £15 a month for emergencies, but when the above three things happened in very close succession, we were obviously incredibly stuck as we had not much more than £100 put aside and ended up having to call the DMP company and make a significant underpayment - which resulted in letters from our creditors because we hadn't met the agreed payment that month.

Now that my debts are virtually clear (final payment on one at the end of this month, and a joint account with my ex that is currently under legal wranglings with our solicitors), my OH will be taking sole responsibility for his debts for the duration of the DMP and for the next few months, the money I would have been putting to the DMP will be going in my savings account to create that buffer for us. Once that's in place, OH and I will decide whether it's worth our while to continue saving, or whether it's better for me to help him clear his debt quicker so that we will be able to do things like remortgage together in the future.

Obviously, my situation is very different from yours, but I'd personally rather have a small amount of savings as an emergency fund, then clear the debt completely. I don't ever want to be in a position again where I have to use credit to deal with a financial emergency, and would rather have the option to pay it with what's in the bank or with a credit card, safe in the knowledge that I can clear the CC as soon as the next bill comes in.