New research suggests that 2013 could be the year when many Australians knuckle down to build personal savings. No matter whether you’re growing a nest egg because of worries about job security or you’ve simply got a bit of extra cash to tuck away these days, it makes sense to have a pool of savings. But you could get more bang for your buck using the money to pay off debts.
According to the latest ING DIRECT Financial Wellbeing Index, one in three Australians is aiming to grow personal savings this year.
Apparently there are a whole range of reasons why we’re focusing on saving. About half (51%) of those who plan to save are keen to build a financial buffer. Around 16% have concerns about job security. And just over one of five say they are now able to save more now because they have paid down debt.
In fact, if you have personal debt like a home loan or credit card it can make sense to use any extra cash to pay down the balance rather than build separate savings.
Financial institutions make money by lending at higher rates than they pay on deposits. So by paying off debt you’ll save more in interest charges than you’ll earn with a high interest savings account.
To see how this works let’s take a look at the difference between some of the most competitively priced debt and savings products. Mortgage lender loans.com.au for instance charges 5.24% on its variable rate loan. State Custodians charges 5.44%. Both rates are around half a percent higher than the top rate you’re likely to earn on a savings account – currently around 4.82% with, say, RAM’s Saver or 4.75% with an ANZ Online Saver.
If you have a credit card balance charging 15% or 20% it’s a no-brainer that you’ll be better off focusing on reducing the balance than building savings.
There are exceptions to this rule. For example if you have a loan used to buy shares or an investment property, the interest can normally be claimed as a tax deduction. So as long as you can comfortably manage the repayments and benefit from the tax deduction there may not be a significant advantage to paying off the loan ahead of schedule.
For most people though it can make good financial sense to channel extra cash into your credit card or mortgage whenever you have some surplus funds available. The beauty of today’s mortgages is that a redraw facility, which is available on most variable loans and even some fixed rate loans, lets you claw back any additional repayments you have made previously if you need the cash now, say for an emergency.
For more ideas on how to become debt free sooner, take a look at my new book ‘Free Yourself From Debt’.