Saving for a rainy day

14 March 2008

No-one knows what the future will bring, but that doesn’t mean you can’t prepare for it. Whatever you earn and spend, experts recommend you set aside at least three months’ salary for a rainy day.

But not everyone can do that. For millions, a savings account might not be an option. It might not even be a good idea – yet.

Save up or pay off debts?
Imagine someone already has £5,000 in a savings account but owes £5,000 to one credit card, two personal loans and an overdraft. Although they’re making money on their savings (probably earning 5-6% in interest), they’re also losing money on their debts (probably costing 15-20% in interest).

Should they use their savings to wipe out their debts? The answer may be ‘no’ if they’re:

1. comfortable ‘carrying’ that debt,
2. able to afford the interest charges, and
3. unwilling to spend the money they’ve saved up.

Even so, it might be a good idea to figure out how much of their savings they really need to hang onto. They might decide to use half of their savings to pay off half of the debt – saving themselves a lot of interest charges without giving up their ‘emergency fund’. Or they might choose to wipe the slate clean by getting rid of their savings and their debts at the same time.

Ways out of debt
Unfortunately, not everyone in debt has that option. But even if they can’t repay their debts in one go, they should still aim to pay them off as soon as possible, so they can stop paying for yesterday and start saving for tomorrow.

Depending on the type of debt they’re facing, they can either tackle it themselves or choose from the various debt solutions available today.

Some people bring their unsecured debts under control by consolidating them with a remortgage or loan. This can reduce the amount they’re paying back every month, although it’ll probably mean they spend longer paying off the debt and could (with a remortgage or secured loan) put their property at risk of repossession.

Others look into debt management. With a debt management programme, people ask a debt specialist to manage their debts for them, asking creditors to accept lower payments and freeze or reduce interest and charges.

For people with more serious debts (normally over £15,000), an Individual Voluntary Arrangement or IVA might be more appropriate than debt management or consolidation. A legally binding agreement with their creditors, an IVA lets them pay a fixed amount every month (based on what they can afford after essential living expenses). After a fixed period of time – normally 5 years – the IVA finishes. Their remaining debt is written off and they’re debt free.

The ‘trick’ is to keep up the habit of making monthly payments once the debts are paid off. With the debts gone, those payments can go into a savings account – saving up for future expenses instead of paying for past ones.

Saving in tough times
Right now, we’re all affected by the nation’s (and the world’s) economic worries. Food, petrol and utility bills are rising, personal debt is at an all-time high, and credit is becoming harder to obtain.

On the one hand, this can push people to save: when we see tough times ahead, we’re more likely to try and put some ‘rainy day’ money aside. But tighter budgets can also make it harder to make any headway.

In February, Birmingham Midshires’ Saving Britain report seemed to back up both these points. Comparing today’s figures with last year’s, it brought good news and bad news about saving.

At the start of 2007, 66% of respondents were putting money aside. On average, they’d saved £813 over the past three months, but ‘raided’ their savings to the tune of £349. Average savings: £464.

At the start of 2008, 69% were putting money aside. On average, they’d saved £814, but taken £961 from their savings. Average savings: minus £147.

While it’s encouraging to see saving becoming more popular, it’s worrying that it also seems to be harder. In tough times, it looks like many would-be savers seem to try harder – but achieve less.

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