Should You Use Savings to Pay Off Credit Card Debt?
Credit cards are a useful tool for building up your credit history but if you're not diligent about paying them off every month your balance may quickly add up. Digging your way out of the mess can be challenging but if you've got some cash set aside, it may make sense to use savings to pay off credit card debt.
It seems like a contradiction to have money in the bank and still be making payments on credit cards each month but that's the position many people find themselves in. If you're in this group, deciding whether to use the money in your account to banish your debt once and for all may be a difficult choice. Whether or not you should pull the trigger ultimately comes down to what your larger financial picture looks like.
Weigh Your Options
If you're on the fence about whether to use savings to pay down credit card debt, the first thing to consider is how much you owe versus how much cash you've got squirreled away. Parting with the money is likely to be easier if you'll still have a fairly decent cushion once the debt is paid off. When your balances are roughly equal the amount you've got in savings, making a move suddenly seems a lot more risky.
On the other hand, it also helps to think about how being in debt makes you feel. For some people, the thought of having credit cards hanging over their heads is enough to cause plenty of sleepless nights. Wiping it out at one go can bring a much-needed sense of relief that surpasses any misgivings you might have about being temporarily cash-poor.
Break Down the Interest
Interest rates on savings accounts are pretty dismal these days, although you may be able to get better return by opening a high-yield account online. Earning even a small amount of interest is better than nothing but the odds are good that the amount of interest you're paying to the credit card company is much higher. Calculating how much the debt is actually costing you offers a sobering perspective on the situation.
Let's say, for example, that you owe $5,000 to a credit card with an interest rate of 10 percent, which is fairly modest as far as rates go. If you pay $200 a month towards the debt, it would take you almost 2 1/2 years to bring the balance to zero and you'd pay over $600 in interest. Now, let's say you have that same $5,000 in a savings account earning an interest rate of 1 percent. Over that same time frame, you'd earn roughly $100 in interest. When you look at it that way, it's easy to see how much you'd be saving by just paying off the debt. Take a look at the chart below. It will help explain the percentage of monthly credit card payments toward interest.
|Time to pay off||2 years 8 months||11 months||7 months||7 years 4 months||2 years||1 year 2 months||2 years 4 months||11 months||7 months|
|Total principal paid||$5,000||$5,000||$5,000||$10,000||$10,000||$10,000||$5,000||$5,000||$5,000|
|Total interest paid||$1,215||$430||$274||$7,508||$1,841||$1,084||$557||$217||$141|
|Portion of monthly payment paid toward prinicipal||80%||92%||95%||57%||84%||90%||90%||96%||97%|
|Portion of monthly payment paid toward interest||20%||8%||5%||43%||16%||10%||10%||4%||3%|
|Monthly payment to pay off in 1/2 the time||$351||$875||$1,295||$307||$988||$1,511||$378||$855||$1,273|
Rebuild Your Reserves
Another thing you should think about before you use savings to pay off credit card debt is how long it would take for you to replenish your account. If you're paying out several hundred dollars a month just for the minimums, freeing up that money should make bulking up your savings again a much faster process.
It's also wise to consider your income situation. If you're expecting it to go up in the near future, that's a big bonus, as far your savings go. On the other hand, if it took you a while to build up your account based on what you're currently making and paying off the debt wouldn't put a ton of extra money back in your budget, you may be better off taking a different approach.
Alternative Ways of Paying off That Debt
If you need some breathing room but you're not quite ready to part with a big chunk of your savings, there are some ways to make paying down the debt a little less expensive. Transferring your balances to a card with a zero percent interest rate, for example, can help you make a bigger dent in what you owe. Just be sure that you read the fine print so you know how long the introductory rate lasts before the regular APR kicks in.
Another option is to simply step up your payoff efforts by throwing every extra penny available at the debt. Selling things you no longer use, picking up a part-time job or starting a side hustle are all ways to bring in a few more dollars that you can use to chip away at your balance.
When You Shouldn't Use Your Savings
There are some situations where it's actually not to your advantage to use savings to pay off credit card debt. For instance, if you don't have a decent emergency fund in place, then using what cash you do have can actually work against you. If an unexpected expense pops up, your only choice may be to use a credit card to cover it and you're once again back in debt with nothing in the bank.
Paying off debts over time versus a lump sum also makes sense if you're self-employed or freelance and your income fluctuates from month to month or you're worried about how stable your job is. Being debt free is a great feeling but it can easily be overshadowed if you suddenly find yourself scrambling to make ends meet because you got laid off or lost your biggest client.
In the end, finding a way to strike a balance between saving money and paying down debt is be the best solution. Trying to do both at the same time may mean that you're not making progress as quickly as you'd like but you're also not having to sacrifice either of your goals.