Most people automatically assume that the sooner they pay off their debts, the better off they will be financially. This doesn’t always hold water.
When you save money in the bank, you are effectively lending them your cash. This allows the bank to make loans to other customers.
The bank makes a profit due to the difference between the rate that it borrows money from you, which we know as the savings rate, and the rate that it charges others for the money they borrow from the bank, which is the borrowing rate. This means you will usually be charged more on the money you borrow than what you will get paid in interest on the money you save with the bank.
It is important to look into all of your options when looking to pay off debts, because there are a small number of instances when the cost of the debt is less than the savings rate.
Some people manage their debt by transferring it to a low interest or interest-free loan (like a balance transfer offer on a credit card).
These people need to look at what their savings account will earn them after tax, versus what is the interest rate on their debt. If the borrowing rate is lower than the savings rate (after tax), there is actually a benefit in keeping the money you intend to use for repaying the debt, in the savings account rather than putting it straight into the loan account.
However, this will only work if you are a disciplined person and will not touch the money sitting in the savings account. If you don’t and end up spending it instead, you can end up in a deeper hole than what you were in before.
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