Jo Holmes, Wednesday November 14, 2007

What benefits you most - cutting your interest repayments or getting the most from your savings? See which strategy is right for you

Is it better to pay off debt or save? Whether you're considering paying off your mortgage or simply juggling stretched resources, the basic principle is the same - you're unlikely to earn as much on your savings as you pay for the privilege of borrowing.

It isn't impossible to find a savings account that pays more in interest than the rate charged on a typical loan - even after tax - but the terms and conditions that apply may be restrictive. You probably won't be able to access your savings immediately in the event of an emergency, so you may not enjoy much benefit even if you do bag the best rate.

Yet it may not be a straightforward choice between either saving or repaying your debts - consider how you would be able to handle a financial emergency. How easy would it be for you to get more credit? If you think it would be difficult, you should aim to build up a small emergency fund before using any spare cash to reduce your debts.

Yet you may be able to build a small nest-egg and make debt repayments at the same time. Debt counsellors suggest putting away enough to cover around six months' outgoings in the event of emergency.

Tackling your debt
Once you've built a rainy-day fund, any spare cash should be used to pay off your debts. Experts claim it pays to prioritise. "Tackle expensive debts as quickly as possible. You need to budget and maximise what you can use to pay off the most expensive debts first. It's all about priorities - you can then work your way down," says Torquil Clark financial adviser Philippa Gee.

How much you should repay can depend on your age. If you have substantial savings and investments and your only debt is a mortgage, you should benefit through paying it off or reducing it significantly. There may, however, be conditions attached - you need to check whether there are early redemption penalties and whether your lender allows one-off or regular capital repayments.

If you are approaching retirement, it may be better to save or invest any spare cash for the future, depending on what other pension provision you have. "Remember, you can borrow to buy your house, but you can't borrow to fund your retirement. There needs to be a balance," says independent financial adviser Francis Klonowski.

Combine and save
There are deals available that allow you to use your savings to keep your borrowing costs down - 'offset' accounts set credit balances in current and savings accounts against your debts (including a mortgage) to keep the interest you pay to a minimum. An offset account may be suitable if you have substantial savings, a high income or are self-employed and keep cash in reserve for extended periods.

If you feel your debts are a problem, you can contact National Debtline 0808 808 4000 for more detailed advice.