One in four Australians are making a big mistake with their money and it’s draining their finances.
Research shows 25% of Aussies are not paying off debt even though they’re sitting on cash savings. And it turns out it’s not something that’s unique to Australians. Researchers in the UK have even coined the term “co-holding” to describe the habit of being in debt while having savings.
There can be perfectly logical reasons to hold both debt and savings. After all, having a pool of spare cash makes us more confident about managing an emergency. The problem is, co-holding could be costing you dearly. Let’s do the sums to see why.
Paying more in interest than you earn
We’ll say Sue has cash savings of $10,000 on which she earns interest of 2.85%p.a. That’d give Sue annual interest income of $285.
Now let’s assume Sue owes $4,200 on her credit card – the average across Australia. Credit card interest rates typically range from 15-22%p.a., and even assuming Sue’s card is at the cheaper end of the scale with a rate of 15%p.a., she’ll be slugged with interest charges of $630 annually.
Chances are, you’re starting to see the problem. By simultaneously holding debt and savings, Sue is out of pocket by $345 each year. Not only is this a cost she could trim by using savings to pay off her debt, the annual interest outflow is making it even harder for Sue to grow savings.
It turns out, Sue’s hypothetical example isn’t so far-fetched. Among the quarter of Australians who have both debt and savings, the average debt is $135,000 while average savings are $45,000. So these people could potentially use their cash to reduce their debt by a third. Almost one in ten have sufficient savings to wipe out their debt altogether.
So what’s holding us back? The answer lies in behavioural science.
Research shows we feel more psychological pain when we dip into savings to make a purchase compared to using debt. We may also fail to consider our overall financial position when making money decisions.
Happily there is a solution.
Offset accounts – make your savings work harder
Credit card debt is the most expensive of all, so it could definitely be worth using savings to pay off the plastic. If you have a home loan, it may be possible to have your cake and eat it too with an offset account.
An offset is a savings or transaction account linked to your home loan. Instead of receiving interest on your savings, the balance of the offset account is deducted from your home loan when interest charges are calculated.
An offset account lets you hold savings guilt-free knowing the money is being put to work lowering the cost of your debt and helping to pay off your home loan sooner.
It can be the ideal strategy if you fall into the debt-plus-savings camp, and could potentially let you save tens of thousands of dollars over the life of your home loan.