Which comes first, savings or debt reduction?

When it comes to money, we get so many different messages whether we should be saving up for a rainy day or getting out of debt. It is hard to know what advice to take when there is so much out there.

Well I am here to tell you that the smartest route to go is to get out of debt before you embark on a savings plan.  Interest rates on credit cards can be up to 30% APR in the UK which totally beats the measly max of 5% you will earn on savings. It is just smart maths to pay off all those expensive debts first.

You need to make a plan of action on how you are going to pay off your creditors. There are several methods:

1. Debt Snowball – this is where you list your debts smallest to largest, regardless of the interest rate and pay them off smallest to largest. The thought process behind this is when you start seeing debts cleared and accounts closed you will get even more enthusiastic to pay off the big debts.

This is not really mathematically sound as you may end up paying off your lowest interest rate first but it does have a great success rate. There is nothing like drawing a line under a debt that you will never have to deal with again.

2. Highest Interest First – this the math nerd’s choice of debt reduction. It does make sense on paper but if your highest interest debt is also your biggest debt that means that you won’t see a lot of progress for a while.

You will need to be very disciplined to stick to your budget without seeing much return for a while but if you have an iron will then this is the plan for you.

3. Debt Tsunami – this method has nothing to do with the numbers. It is all about emotion. You pay off the debts that have the most emotional impact on your life. We don’t feel guilty when we owe money to a credit card but it is a totally different situation when you owe a substantial sum to a family member.

You invoke the Debt Tsunami when you have borrowed from your nearest and dearest and can’t bear to see them at Christmas. You pay your emotional debts first then go on to use one of the other methods to clear the rest. When you are emotionally free, it is easier to find the strength and perseverance to pay off your other creditors. Once you get your debt sorted then you can start looking to the future and a lovely nest egg.