If you’ve decided it’s time to get serious about your financial future, or maybe you’ve been lucky enough to come into some extra money, congratulations! Now comes the hard part: deciding whether to pay off those debts hanging over your head or squirrel it away for another day (of course there is the option to spend it, but as fun as that may be, I'm not going to suggest that—sorry!)
Generally speaking, debt winds up costing you money. Assuming you have credit card debt—most Canadians do—the simple answer is to pay these off first. Not so fast, Captain Canuck. In the world of finance, there are no simple answers! So we’ve outlined below when it’s best to SAVE IT UP and when it’s time to PAY IT OFF.
SAVE IT UP: If you don't have debt or an emergency fund.
If you don’t have debt but you also don't have any extra funds, use that newfound money to set up an emergency fund. Why? Because unexpected emergencies, from home and car repairs to job loss, can have you reaching for the credit cards and racking up significant debt in the future. Think of your emergency fund as a “safety net” that keeps you safe from high-interest credit cards!
So how much money should you keep in your safety net? Most financial experts recommend stashing away enough cash to equal three- to six-months of expenses. (If you’re single or both spouses work, three months should be sufficient; if there is just one breadwinner in the family, six is a safer bet.) So, if you need $3,000 to make it through the month, you should have either $9,000 to $15,000 put away depending on your situation.
SAVE IT UP: If you can take advantage of an RRSP.
If your employer matches the money you put into your RRSP, don’t pass it up. That’s free money! So not only are you saving, you’re also earning.
Let’s say your company matches half of every dollar you contribute, up to 5% of your salary. You make $50,000 per year and contribute 5%, or $2,500, of your own money. Your company then chips in half of that, or an additional $1,250. Jackpot! And that free money is also likely to be more than you’ll pay in credit card interest for the year.
PAY IT OFF: If you have high-interest credit cards.
The amount you’re paying in credit card interest is most likely much more than the amount you’d earn by putting money into a savings account. But where do you start?
If you’re like many people who simply pay the minimum each month, you’re mostly just covering interest charges—so you pay a lot and very little comes off the balance. So when you’re able to pay above the minimum, you’ll want to take a look at the Annual Percentage Rate (APR) for each card, which you can find on your statement. Focus on paying off the cards with the highest interest rate first, while maintaining the minimums on the lower interest cards.
Some credit card statements also include a section detailing how long it will take to pay the card off if you pay only the minimum; not only is this an eye-opener, it can help you decide which ones to bulk up your payments on.
PAY IT OFF: If you need to boost your credit score.
A good portion of your credit score is determined by the amount you owe on credit cards versus the amount available to you. (If you're not sure what your credit score is you can book a free Credit Building counselling session and one of our counsellors will pull your credit report and score and review it with you.)
If your debt-to-credit ratio is high, chances are your credit score is low. And a low credit score not only means a higher interest rate on loans, but it can also affect your ability to even be approved for a loan altogehter.
So if you’re planning on purchasing a new home or vehicle in the near future, it may be in your best interest to pay down those credit cards. With lower credit card utilization, you may be able to get significantly lower interest rates on a loan or mortgage.
PAY IT OFF/SAVE IT UP: You have student loans, car loans, and mortgages.
Now this is a toss-up.
Student loans, car loans, and mortgages typically have a much lower interest rate than credit cards or payday loans, so there’s generally no pressure to pay them off quickly as long as you can make your regular monthly payments. You can focus on paying off high-interest debt first or saving.
However, if you have a solid nest egg, you’re contributing to your RRSP, and you’ve paid off your credit cards—sure, pay these loans off. It’s one less thing to worry about each month!
FOR MORE ADVICE/TIPS & DEBT
If you’re still unsure about whether to save money or pay debts, we can help. Contact Credit Canada for a free credit counselling session with a certified credit counsellor. Call 1-800-267-2272 to schedule today!