Pay off debts or save?Pascal Gagnon
“Should I pay off my debts or save?” A question frequently asked by consumers.
Some studies show that Canadians, for the most part, give priority to repaying their debts instead of saving money. As this is a question that will sooner or later come into the mind of any consumer, here are some of the factors to consider when it comes to determining whether it is time to save or pay off your debts.
Types of debts
Since not all debts share the same value or have the same impact on your personal finances, it is necessary to analyze each type of debt separately.
- Credit cards
In the list of possible credit products, the credit card usually ranks first for having the highest interest rate. It is therefore necessary to repay your credit card debts in priority, as a high credit card balance can cause damage on your budget.
- Deferred payment contracts
When you make a purchase from retailer and you get financing for your purchase, you also enter into a deferred payment contract. It is a consumer loan, usually includes a store credit card from where you made your purchase. Deferred payment contracts are a very popular way to finance your purchases of furniture or electronics, for example. They are often linked to offers like “Buy now and pay later”.
What you should remember about this type of debt: its interest charges are as high as credit cards and can easily get out of hand.
Prioritizing the repayment of consumer loan debt is therefore a sound practice that saves on interest expense.
- Car loans
Car loans have certain details that vary from one car loan to another. It is therefore important to pay special attention to some of the factors included in this type of loan.
- The duration of the loan
In an ideal world, the payment period for your car loan should not exceed the warranty period on your vehicle.
When your vehicle is no longer under warranty, you are still making your car payments, but may find yourself having to pay large amounts to repair your vehicle. The financial problems can result from the double payment of the repairs on the vehicle in addition to the payment of the car loan.
If your budget allows it, I strongly encourage you to accelerate your payments and pay off your car loan before the end of the loan period.
- The interest rate
If you are one of the lucky ones who have received a 0% interest or a very low interest rate financing, the repayment of your car loan need not be a priority.
On the other hand, for “2nd chance” financing rates, you will have a much higher interest rate. It is therefore important to prioritize this expense and repay it quickly to avoid a large amount of interest payments.
Generally, the mortgage represents the biggest debt a consumer will have during his or her life. Many people make the quick repayment of their mortgage a priority.
To put this debt in perspective, which can seem substantial for the consumer, it is necessary to consider certain factors:
- The interest rate
Mortgage financing of the past years represents the lowest level of interest ever. The rule is simple: the lower your interest rate, the lower you pay in interest charges. In addition, when selling your home, the resale value usually recovers the interest amount you have paid for your mortgage.
- The resale value
“A house is an investment, not a debt,” a phrase we often hear when it comes to mortgages. Why is contracting such a large debt seen as an investment? It is because a house also has a resale value, a factor which must not be overlooked.
As the mortgage balance of a home decreases, its net worth increases. Add to this an interest rate (fixed or variable) that will remain relatively stable for several more years and a possibility of increasing your employment income over time; these are all factors that make your house an investment and not just a debt.
- The impact on you
There is one last factor that should not be overlooked when thinking about accelerating the payment of your mortgage: the sacrifices. Indeed, to repay this debt faster, you will have to make sacrifices not only in your budget, but also in your lifestyle. It is essential to assess the extent of sacrifice versus the importance of paying your mortgage quickly. Will it be worth it in the end? Pausing many aspects of your life other than your finances is not necessarily recommended. It’s a good idea to think about this also.
The management of your debts must go hand in hand with your age, as well as the stage where you are in your life. A student leaving University will not have the same budgetary issues as a mother in her forties or someone who is recently retired. Each stage has its own set of challenges and debts, so it’s important to consider where you are when you’re wondering whether it’s better to save or pay back.
Although it is not necessarily a priority to pay off mortgage debt, it is important to pay for it before retirement. Retirement generally generates a decrease of income, so it is better not to have such significant debt.
It is possible that some of the benefits of saving are more important to you than the repayment of your debts. Here are some examples of savings incentives:
- Group RRSP
If you are fortunate to an employer who contributes to the employee RRSP, you will probably be tempted to take advantage of this benefit and grow your RRSP more quickly.
- Your spouse’s RRSP
You may also want to put your income in your spouse’s RRSP to divide the total into your retirement.
- Tax deductions
Another advantage of the RRSP is the allowable reduction in the level of taxation. That way you could get a tax refund annually and use that amount to pay off some of your debts.
- The RESP
Your contributions to a Registered Education Savings Plan (RESP) could be enhanced with the Canada Grant through the Canada Education Savings Grant (CESG). Residents of Quebec can also benefit from the Quebec Education Savings Grant (QESI). While it is difficult to predict the post-secondary plans and education costs of your children and grandchildren, an RESP could save you headaches and debt later on.
Your ability to cope with the unexpected
Financial planners agree on the importance of an emergency fund. The emergency fund should include at least the equivalent of three months salary. Do not have emergency funds? If you do not have an emergency fund, a priority would be to start saving for it as soon as possible. Only the repayment of credit cards should exceed in importance to the savings of an emergency fund.
An unexpected event could cost you thousands of dollars in debt. This is why it is strongly recommended to set up an emergency fund before the prioritization of certain debts mentioned above.
So, pay off your debts or save?
In the end, the choice between repaying your debts or saving remains yours. If you are unable to determine which option would apply to your financial situation, a financial planner can always guide you on the right path.
When paying off your debts is the only solution
Unfortunately, your level of debt may be such that you cannot consider the savings option. This is when it would be better to meet a licensed insolvency trustee who will advise you. Contact Ginsberg Gingras without hesitation. They may have the solution to free you from your debts quickly so you can start saving.
Get a free evaluation by clicking here or the orange “free online consultation” button at the bottom of the page.
So, it’s up to you now! Will you pay off your debts or save?