With the current economic situation in Nigeria, many people have been more encouraged to save and invest especially in foreign currency to avoid getting into a financial runt. However, several people are already in debt and must then decide how to apportion their earnings towards savings/investments and settling debts. We are usually saving towards a goal which could be long or short term. In most times, we are so eager to fulfil those goals that we may put off paying off debts to save and invest more as doing otherwise would mean we would spend a longer time achieving those goals especially when the debts are overwhelming. In this article, we would be looking at some factors to consider when making this decision.
Interest rates are typically stated per annum and in a bid to combat inflation, lenders charge higher rates for longer loan terms. For example, you take a loan of ₦100,000 at 10% per annum for two years making you pay ₦10,000 interest per annum and a total repayment of ₦120,000. If you request for a longer loan tenure of say six years, the per annum interest rate would be higher regardless of when you repay the loan. It could rise to say 15% per annum making you pay a higher interest of ₦15,000 per annum and a total repayment of ₦190,000 on the same loan amount but with a longer loan tenure. Hence, it is always better to choose loan terms that are as short as practicable as paying less interest per annum is also an indirect saving. However, debt with good leverage is good debt. If you invest an amount obtained from debt at an interest rate higher than the loan’s interest rate, you may consider extending the loan term to give your investment more time to mature and earn more. With this, you may be able to use the investment earnings to pay off the loan and have residual earnings.
Having a good debt repayment strategy is key. You can start by paying off the debts with the highest interest rates first. That way, you can pay off significant debts and have more money to boost your savings and investments bank. You may also have some overdue debts accruing penalties. Pay these off as soon as possible to stop the penalties from accruing and minimize your total repayments on those loans.
Another consideration is the currency the debt is in. If your debt is in a currency more expensive than your functional currency and the exchange rate is volatile e.g. earning in Nigerian Naira and taking a loan in US Dollars, you will also have to consider the impact of the increasing foreign exchange rate on your repayment amount in your earning currency i.e. the Nigerian Naira. Let us look at an example using a fictional currency called USM and the US$. You earn in USM and take a US$500 loan on 01/01/2021 when the exchange rate was US$/100USM. If the interest rate keeps rising and is US$1/110USM by 01/02/2021 showing a 10% increase, the loan principal and interest just increased by 10% as well without even considering the interest rate yet. In this case, it is advisable to pay off the debts as fast as possible. However, if it is the other way around where the value of your earning currency keeps increasing then, the loan principal and interest just reduced by 10%. In this case, you may consider prioritising savings and investments over loan repayment. Check out our article on Debt Management for more information on how to manage debt.
However, do note that whilst paying off your debts and funding your savings and investments bank, it is important to still set aside an emergency fund to deal with unexpected expenses. One reason people run to take loans is due to not having an emergency fund. If one puts all their money into settling bills, debt repayment and funding their savings and investment bank, they may become cash-strapped and take yet another loan or withdraw from their savings and investment bank to pay expenses. In the long run, they may just be chasing their tails by depositing and withdrawing from their savings and investment bank and settling loans while taking on new ones. Check out our articles on The Art of Budgeting, Managing Savings and Spending and Building an Emergency Fund for more information on how to budget your finances.
In conclusion, deciding on which to prioritise, either savings/investments or debt repayment depends largely on your prevailing circumstances. The ideal balance needs to be found and the above-stated factors should help you find it.
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Hund, L. (2021, May 12). Should You Pay Debt Before Saving? Bankrate. Retrieved October 16, 2021, from https://www.bankrate.com/banking/savings/these-guidelines-will-help-you-decide-whether-to-pay-down-debt-or-save/
Shinn, L. (2021, January 27). Should You Save for an Emergency or Pay Off Debt First? The Balance. Retrieved October 16, 2021, from https://www.thebalance.com/should-you-save-money-or-pay-off-debt-960844\