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January 2006 - You Cannot Start Saving If You Are In Debt

You Cannot Start Saving If You Are In Debt

☳ by Adam Aspilla

The essence of financial planning is to save money for the future to buy a house, for retirement and for whatever worthwhile purposes. However, if the interest rate of your saving (investment) is less than the interest rate of your existing debts you are losing not saving because the exorbitant interest rate on your existing debts would wipe out many times your interest income on your saving.

 

There are people who insist on saving with interest rate much less than they are paying on their credit cards and personal loans. A good illustration was a couple with $20,000.00 savings in the bank with an interest rate of about 3% annually. At the same time they had an outstanding $45,000.00 credit card debts and personal loan with average interest rate of 19% annually. They only pay minimum payments on their debts which practically applied only to interest.

 

The couple’s savings earned about $600.00 annual interest while they spent for the same period an amount of $8,550.00 in interest expense of their outstanding credit card debts and personal loan. The net result, the couple lost $7,950.00 ($8,550.00 - $600.00) for their interest income was dissolved many times by the interest they paid on their outstanding debts.

 

Had the couple used the $20,000.00 savings to pay down their outstanding debts to $15,000.00 they would have reduced their annual interest expense to only $2,850.00 ($15,000.00 x 19%), and the balance of $15,000.00 was much more manageable to pay off early than the $45,000.00.

 

It would be prudent, before you start saving to determine your existing debts, the interest you are paying, and the interest you would earn on your plan saving. If the interest rate on your plan saving is higher than what you are paying on your outstanding debts, saving is good for you. However, if the interest rate of your saving is lower than the interest rate you are paying on your existing debts, as in the above scenario, you are better off to first pay your debts with higher interest rate and save after you have liquidated those debts.

 

Saving is good for your future, but if you pay more interest on your existing debts than the interest income you earn on your savings, you are not saving at all but you are losing. You cannot really start saving when you are in debt under the above-mentioned situation. Clear up your debts first and start saving. 

 

Adam Aspilla is a Senior Financial Counselor of the Debt Clinic of Canada Inc. and the author of the book, You Can Negotiate All Your Debts. He also writes a biweekly column, “What Matters In Life” in “Taliba Newspaper. For free initial, professional and confidential consultation, please call 905-306-7572.