In many of my past articles, I’ve discussed the importance of saving. Last month (‘New Year’s Resolutions’) I referred to saving and paying off debt simultaneously. Sometimes it’s the same thing; sometimes it isn’t.
If you’re paying off debt, I think the important thing is isolating what debt you’re paying off.
I’m perplexed every time I hear someone say that they’re trying to pay off the mortgage on their house in less than the allocated 20 years, yet they have rolling credit card debt and no problem with trading in their car every four years as the instalments are ‘just a monthly expense’.
If you’re paying off debt, you should be paying off the one with the highest interest rate first. Don’t think that paying off a little bit of each type of debt is most productive. I sometimes feel that if there’s a debt with a relatively small balance, it’s most rewarding just to pay that debt off first.
The feeling of having one less creditor to pay is sometimes the impetus we need to continue paying off our debts. But, overall, you’re saving more interest expense if you pay off the debt with the highest interest rate first. That’s why your mortgage is often the one you should be paying off last. Keep paying your instalments, of course, and if you have extra to put in there, absolutely do so, but because your mortgage will generally carry a lower interest rate than other debt, it’s often the one we should be paying off last.
If you have more than one mortgage, apply the same principle.
Throw every extra bit you can into the mortgage that carries the higher rate. Don’t split down the line between the two.
Different people have different views on whether debt is good (we all need a gearing ratio) or whether debt is bad (you should have no debt), but consider your overall portfolio.
Personally, I sit with a limited debt balance, with low(ish) interest rates and only pay the absolute minimum I need to every month.
Any other savings goes directly to high yield investments. This is a very personal choice though and often has to do more with how well you can sleep at night and what risk propensity you have. Consider carefully.
Please note that the author of this article (Gizelle Willows CA(SA)) of this article is not a certified financial advisor in terms of the Financial Advisory and Intermediary Services Act 37 of 2002. Accountancy SA and the author cannot be held liable for any loss (including indirect and consequential loss) arising from your reliance on the opinions given in this article. Should you nevertheless elect to rely on this article, you do so at your own risk and agree to indemnify Accountancy SA and the author from any loss or damage that you may suffer as a result.
Author: Gizelle Willows CA(SA) MCom Finance is Senior Lecturer in Financial Reporting at the University of Cape Town