As everyone tries to monitor their budgets and save money, there’s probably not been enough discussion about what to do with the money you save. Most Americans right now have huge amounts of debt and no savings to speak of. When you only have enough money to put toward one or the other, which is the smart investment for the future? Which will save you the most money in the long run?
In almost every instance, it is far better to put your extra cash into paying off debt. Though it is a huge advantage to have savings put aside, the more immediate problem is the huge interest rates and fees the credit card is costing you (see this post). Even if you save up several thousand dollars into a savings account and still make the minimum payments on your credit card, you’ll still wind up in the hole. Here’s how.
The minimum payments on your credit card are going to keep you in debt for a very long time. They’re not there to pay off the card with the minimum cost to you as a consumer – they’re to make sure the credit card company makes as much money as possible while still protecting its investment. From the credit card company’s point of view, the more interest they can collect, the better. That means the payments are set up to allow for you to be paying interest as long as possible.
So even though you have several thousand dollars in savings, you may also be paying an equal amount of money in interest. That means you haven’t saved money at all – you’ve only come out even. And that’s if you’re lucky. If your debt is high enough, putting money into your savings can actually mean you spend more money in interest than you put away in savings. Saving money is actually costing you money under those circumstances.
Meanwhile, if you pay off your credit card debt instead of putting the money toward a savings account, you’ll pay far, far less in interest. What’s more, once the debt is fully paid off, you’ll be able to put money toward a savings account without continuing to lose money in interest. So put every penny you save on budget cuts toward paying off that debt, and start saving for a nest egg only after that step is complete.
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It is clear that you should pay off your higher interest rate debt than putting your money…
Pay off the debt always but also worth keepping an emergency savings account for those unexpected bills. Other thing a lot of people should do but don’t is to pay off the debts with the highest interest rates first. Sounds obvious but am always amazed when i speak to people who are paying down debt that the card or debt they are trying to clear first is not the one with the highest interest charge.
A very well written article. I always have to have an emergency fund. That’s one thing I can’t stop having. Good point David.