Pay debt or save? What to do first with your holiday bonus

Aneth Ng-Lim

Posted at Nov 26 2019 08:57 AM

Is it eavesdropping when the stranger sitting next to you is talking so loudly that the entire restaurant can hear her?

Stuck in a row of tightly packed dining tables, I could not help but overhear what the stranger next to me was planning to do with her year-end bonus. She was boasting of setting aside 25 percent in savings and then spending the rest on herself and gifts for family and friends.

Normally, I would applaud the 25 percent saving goal but when she went on to share with her friends that she will start seriously paying off her credit card debts next year, I wanted to join the chat and tell her, "no, no, no, wrong move." Pay your debt first and then save.

It’s a fact of life that most adults owe some form of debt. You could have unpaid balances on your credit cards, or have a car or housing loan, even some personal IOUs with family and friends. To some, it’s a more serious problem as they walk the fine line between drowning in debt and keeping their head barely above water. How to make sure you don’t end up as the former and not even the latter? Well, it’s simple math, really or you can ask yourself these five easy questions.

#1 Which one has higher interest – your loan or your savings?

Sadly, the more common answer will show that you are paying for a higher interest rate with a loan than earning interest from your savings. A quick scan of the banks show most only pay 0.25 percent interest, per year on your savings. There are also conditions like you need to maintain a minimum balance to earn interest, and even limit withdrawals to once or twice a month. Compare that to say, housing loans, that now range around 6.5 percent to 8 percent annual interest rate and it’s easy to see that one will cost you more than the other.

#2 Do you know how much interest rate you are really paying?

Not all interest rates advertised are what they seem. Let’s take credit cards for instance. I own one that shows the interest rate as 3.25 percent. That seems pretty low but it turns out that is the monthly rate. The annual percentage rate or APR is actually 3.25 percent x 12 months which equals 39 percent! No wonder consumers who owe their credit cards and only pay the minimum due will take years to pay it off. Make sure to read and re-read the Terms and Conditions of any loan you apply for.

#3 How much is it costing you to carry all your loans?

It’s important to know how much you are paying in interest alone with all the loans that you have. In housing loans, the hierarchy of payments could mean that you spend the first few months or years mostly paying interest so you will see little change on the principal amount. That can also be true for car loans. Credit card companies have different policies and rates. But as with all things, always good to have the facts before you sign on the dotted line. Yes, you need the loan, but know how much interest you are paying because that can be a wake up call. Some who find out just how much actually decide their dream care or house can wait, and take out a loan later than sooner.

#4 Will there be penalties if you pay off a loan earlier?

I do not like paying for annual fees, so when I learned that my bank will not waive it, I informed them I will close the credit card. But I bought a sofa on zero percent installment and will need to pay that off first. When I was about to do so, the bank told me there is a charge for cancelling the transaction! It felt so unfair that they penalize you for paying off a loan earlier and they call it the cancellation processing fee. Note that the fee could go as high as 4 percent of the unbilled portion depending on the loan you availed.

#5 How’s your emergency fund doing?

There is one instance when I would likely agree to put saving first over debt payment and that’s when one has no emergency fund and needs to start one. Maybe it will help you sleep better at night. Or it can give your spouse and children greater security especially in volatile economic times. It never hurts to know that there is cash available to you should you or your family need it so this one is a most acceptable exception.

On question #1 alone, you may already be convinced to pay off debt first but I hope questions #2 and #3 will set you firmly down that path. Bonuses are a welcome relief when you have been living from paycheck to paycheck but that breather will last longer if you pay down your debts and have a wallet-responsible holiday season.

Disclaimer: The views in this blog are those of the blogger and do not necessarily reflect the views of ABS-CBN Corp.