When you are in debt, having income left over each month raises an interesting question. Should you use the funds to repay your debt or should you save or invest the money? Experts are always touting the importance of having an emergency fund. Should this take precedence over repaying debt? The most effective way to use extra income varies by situation. Learning more about the options will help you make the right decision.
If you have credit card debt and qualify for a new card with an introductory zero percent interest period, explore this. Make sure that the transfer fee is lower than the interest rate on the current card. Transfer the debt to the new card and repay it before the zero interest period expires. Breaking the debt into installments may even allow you to save money while you are repaying debt.
Zero interest offers are not available for all types of debt repayment. However, a personal loan with a lower interest rate may be available. For example, some people are able to secure personal loans featuring lower rates than their auto loans. This allows them to save money while repaying their debt. If this is not an option, apply extra income to repaying the debt. Once you become debt-free, begin saving or investing the money previously allocated to debt repayment.
When savings and investment interest rates are higher than interest rates on debt, it is wiser to save or invest some of the extra money and repay the debt gradually. You will earn interest or investment income that can be reinvested or applied to debt repayment. Using the extra money to repay debts enables you to become debt-free more quickly than anticipated.
Many people do not consider making extra payments on large debts like a mortgage. If they have extra money left over each month, they save it. However, this approach could cost them a lot of money if mortgage rates are higher than savings interest. Research published at the end of 2011 indicated that the average homeowner would by £41,665 better off if he or she paid an extra £300 toward the mortgage rather than depositing the money in a savings account.
Repaying debts can also have tax benefits. Money held in a standard savings account is subject to tax on interest earned. If savings and debts are held with the same bank, you may be funding your borrowing by paying a higher interest rate on debts than you are receiving for savings. Even if the extra income will not cover all outstanding debt, repaying as much as possible is still worthwhile.
When determining whether to repay debt or save/invest the money, the best approach is whatever allows you to repay debts most quickly at the lowest cost. When zero interest or lower interest repayment options are available, take advantage of these. If investment and savings interest rates are higher than the rates associated with your debts, save money to earn extra income while gradually repaying debts. You will soon be enjoying a debt-free life!