Should You Get Rid Of High-Interest Debt Before You Start Saving

Written on November 27, 2007 by Tezza

Tuesday’s weekly guide to Personal Finance from 4EvaYoung.com

One of the most often asked questions I get is whether it is better to pay off high interest debt before starting a savings plan. The logical answer to that question would in most instances be to pay off high interest debt first. This is especially so if you are finding it hard pressed to find an investment or savings strategy that has higher returns than the prevailing interest you are paying on the debt. However, while on the surface this course of action seems the most logical it may be worth a second thought. Here are my thoughts on should you get rid of high interest debt before starting a savings plan.

1. Stop Focusing On the Symptom Rather Than The Cause

In our over medicated and stressed out world we are quick to grab the latest quick fix. Instead of dealing with the cause of our problems it is often easier to deal with the symptom so that it doesn’t slow us down from our heavily scheduled lives. We are quick to pop a Panadol to suppress the headache instead of dealing with the lifestyle imbalance that created the headache in the first place or why we reach for the quick thrill as a crutch to alleviate our disenchanted life.

When it comes to debt elimination, it is often easier to face the problem by trying to dig yourself out of debt instead of facing your reasons why you are in debt to begin with. If all you focus on is debt elimination by gritting your teeth and embarking on a disciplined debt repayment schedule you will eventually pay off all your debt but you would have missed a vital opportunity to face your current causes of why you get yourself into these kind of predicaments to begin with. Worst still are those who seek to avoid ever facing their demons by seeking out debt consolidation firms, drawing down equity from their homes or borrowing from unscrupulous lenders.

Rather than look for a scapegoat, look at the root causes of your behavior and habits that cause you to spend beyond your financial means. Until you can figure out why you created this financial mess, you will only be doomed to repeat it once you pay off your debt.


2. Work Out What Is Good Debt And What Is Bad Debt

Not all debt should be treated the same. Debt that is geared towards the accumulation of assets with potential to grow in value over time is considered good debt, these are things like debt used to purchase property, invest in a business or margin loans to purchase shares. Bad debts are generally in the form of credit cards, consumer credit, car loans and personal loans. They have no longer term intrinsic value and generally over time do not add more value to your life.

One simple way to determine if a debt is good or bad is whether it is tax deductible. Generally debt used to purchase assets are tax deductible. It makes little sense for example to speed up the debt repayment schedule for debt your getting a tax deduction and long term growth on while you have bad debt accumulating higher interest. Good debt should by and large be left alone to do it’s thing. What is left should be a list of all the bad debts you have managed to accumulate over time and these should be tackled as a priority.

The aim is to eventually cut up the credit cards and close down personal loan accounts so that you can’t be tempted to get yourself in that position again. You’ve already proved that you lack discipline with money so why should you trust yourself in the future with easy access to credit. These days with debit cards which function like a credit card but draw money directly from the customers savings means there is really no excuse to own a credit card. If you don’t have the money to purchase something then don’t. The world isn’t going to end and your life is not going to fall apart because you couldn’t get that latest new gadget.

3. Is There A Better Option For Your Money

While no one relishes the fact that they have debt hanging over their heads, some rare moments in life may present itself where paying of high interest debt is not in your best interest. This may come about when your employer or the government is giving incentives by co-contributing towards your retirement savings. Some employers will match the money contributed to a retirement savings account and government has on instances provided incentives with similar schemes to boost peoples retirement packages up to a certain dollar limit.

If for example you contribute $100 towards your retirement savings and it is matched either by your employer or the government then effectively you have just made a 100% gain on your money without risking anything. You’ll be hard pressed to find any financial institution or otherwise giving you a return on your investment in the range of 100%. If you are being charged interest on money loaned to you in this vicinity then you are in real strife and beyond help.

There have also been periods through history where the stock market and other investment vehicles have provided higher returns than even high interest debt. Thus in these rare moments you need to weigh up whether capitalizing on these short term windows of opportunity are better served long term or is your need to get your debt cleared a higher priority for you.

4. When You Have Put Yourself In A Hopeless Situation

While I am a positive person by nature, or would like to think so it saddens me to sometimes see people making mammoth sacrifices to pay off mountains off debt when it’s a lost cause. They are clinging to the pipe dream off one day getting them self out of their self imposed mess only to be digging a bigger and bigger hole in the process.

While it’s exciting to see people getting their lives back on track and out of debt through hard work and commitment for some it’s better to bite the bullet and say I’m paddling up stream, I’m exhausted and I’m going nowhere. There is no point getting yourself out of debt by emptying everything you own and in the process putting yourself back decades financially. When these instances arise it’s time to seek professional help and decide if bankruptcy might be a better path for your circumstances.

While I’m no advocate for bankruptcy and I certainly believe that you have a duty and responsibility to bail yourself out of your own mess sometimes it may be the last resort that needs to be put on the table and discussed. Whatever the reason for your financial mess, maybe it was external circumstances like loss of employment, illness or sheer stupidity, the bankruptcy system and legal framework is in place to give people a fresh start in life.

5. Saving And Debt Elimination Can Go Hand In Hand

While you are embarking on a debt elimination strategy there is also scope for you to consider a savings strategy simultaneously. You don’t need to wait till all your debt is cleared before beginning a savings plan. You could allocate a percentage of your income towards debt elimination while also committing yourself to a percentage of the income towards a savings plan.

What this does is it begins a new habit in your life which is geared towards savings, investing and growth. You want to be able to get to a stage where you have eliminated your debt and also have savings to show for it. It means that you get a kick start in your savings and investment strategy as you have had time to develop that habit. Too often people who diligently pay off debt end up cycling back to the same old habits that got themselves there in the first place because they haven’t taken the time to develop better money management habits.

Popularity: 14% [?]

Posted in Personal Finance