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Why Saving Money is Better Then Paying off Debt in Advance

Updated on May 29, 2013

Introduction

Many financial experts say that it is better to pay off some debt in advance then to have savings. The reason for this is that the investment yields are not as high as the interest on mortgage and other loans. I would, however, side with the more traditional view, and say that it is better to have a safety net, that it savings from any of your earnings that remain after paying the regular debt obligations. Below are some of the reasons why it is better to save and invest, rather then paying debt off in advance. 

Advance Payment Penalty

Many banks penalize debtors who want to pay off debt in advance with even higher interest then the regular interest rate on the loan. Obviously, when loan interests are already high, it is not a good trade off. 

Compound Interest

Anyone with a basic financial education knows about the power of compounding interest. Even if you put your savings in an automatically renewing CD, over the decades they will earn more yields (in the absolute terms) then the money you pay off your debt with. 

House Poor

When you use all your money to pay off your debt, you become house poor. As I have described in this article, not having any money left for your own enjoyment, and for savings, can have many negative emotional and social effects. 

Unemployment Fund

You should have savings that equal to at least 6 months of your regular monthly expenses. If you loose your job they will back you up (together with the unemployment aids that you will receive if you applied for it). If you don’t have that, than you will have to accept any job you are offered, irrespective of the salary and other conditions offered. That too has many negative emotional effects.

Emergency Fund

Have at least 1 per cent of your house’s/apartment’s value saved up in case anything breaks down and has to be repaired. Also in the event of an illness, you can use your emergency fund. 

Insurance Fees

It is advisable to have at least two insurances; property insurance, and health insurance. You need to pay for their fees. These complement your emergency fund. If you have a car, it is also good to have insurance on that too. 

Pension Funds

College graduates should set aside at least 5 per cent of their monthly net salary for their pension life. The older, the more is needed for a comfortable pension life. 

Children’s Funds

Children will need to go to college, and that is not cheap. They will also need financial help with their wedding, their first apartment/house, and their children. 

Comments

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    • Michael Jay profile image

      Michael Jay 

      7 years ago

      Great hub, Csanad! You should have saved this for the next month's Hubpages contest. Anyway, hubbers like me can also use this hub as reference. Thanks a lot for sharing! :)

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