‘Should I use my spare cash to pay off debts quickly – or put money into savings?’

MoneyMagpie Editor and financial expert Vicky Parry weighs up the pros and cons of both ploughing money into savings, or supercharging your way out of debt

Having spare cash is a great position to be in – but deciding what to do with it can be mind-bending.

Do you pay off your debt? Put it into a savings account? Or should you put it in the stock market or other investment? Let’s take a look at your options.

Consider your immediate circumstances first

Spare cash is a great thing, but while it’s tempting in the moment to do something with it for ‘future you’, think about the short-term first. If you don’t already have a safety savings net, consider putting at least some aside before you look at paying off debt. If you’re now receiving more money than previously thanks to a promotion or have changed something that gives you spare cash every month like moving to a cheaper rental property, you can afford to think about your options.

Paying off debt first is generally the best approach when you receive a windfall or a higher monthly income than before. However, the type of debt you have can impact what you decide to do.

Credit card debt

Think about what you want to do with your credit cards after paying them off. If you intend to continue using them, can you do so responsibly and pay in full each month? If so, then clearing your debt makes perfect sense.

If you have no cash savings, it can be tempting to keep the spare cash and not clear your debt. This is costing you a lot: savings interest rates will never be as high as your credit card interest rate. But clearing a debt which leaves you with no savings can put you back into the cycle of spending on your credit card again, so you need to know you’ll change your spending habits when the debt is cleared, and pay off in full each month from now on.

You also need to consider that paying off a large credit card debt in one go can trigger a credit limit reduction. Card providers like you to use around 20% of your limit to be considered a “good” customer – if you stop using your card, they could lower your limit. If you plan to apply for more credit soon, such as a mortgage, consider delaying paying off in full. Reduce the debt but keep some, as this will prevent a shock credit limit decrease (which could impact your credit score).

Loan debt

Loans can be cleared with a windfall – but there may be extra costs to doing so. Check for any early repayment fees before you pay off the full amount. These fees could wipe out the benefit of putting your spare cash into a separate account (with a good in-credit interest rate) to pay off your monthly instalments automatically instead.

For example, let’s say you have twelve months left to repay and your savings would earn you £200 in interest over that time. If the early repayment loan charge is more than £200, you’ll be better off continuing to pay it off monthly. Setting up a separate account to automatically pay it off will give you peace of mind that it is, in effect, a cleared debt – and you won’t be tempted to spend the spare cash in the meantime.

Car finance debt

If you’re on a car finance contract, there are usually penalty fees for early repayment – check the fine print of your contract. However, if you’re coming to the end of the hire period, it’s a good time to decide whether you can put your windfall towards the balloon payment to own the car outright.

When to invest spare cash

Debt will always be more expensive than savings interest will earn for you. However, if you have manageable debt – you pay your credit card, loans, and mortgage monthly payments in full each month – you can consider longer-term gains.

Investing is always risky, and you can lose some or all of what you put in. But if you’re financially stable, investing can set you up for a better future. Drip feeding investment money is a good way to get started, which is where you set up a regular payment into a Stocks and Shares ISA each month to invest, rather than investing a lump sum in one go. This helps mitigate market fluctuations.

If you want to learn more about investing, sign up to the MoneyMagpie investing newsletter for regular hints and tips about getting started, types of investment, and what’s looking hot (and not) on the market.

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