This is a question I get all too often. Yep, the old ‘pay off credit card debt or build savings first’ debate.
“Chris, I’ve got credit card debt of $2,000 and a $8,000 personal loan, but I want to put some savings away for a new home, or new car, or… whatever. Should I be paying my loans off first, or begin putting savings away?”
Maybe you even regret getting yourself into so much debt. But, what’s done is done, it’s time to move forward.
Paying Off Debt vs Saving
This is both an easy question and a tough question.
It’s easy because, from a financial perspective, it’s a no-brainer.
The interest rate on your credit card will likely be much higher than the interest paid on your bank savings, so why, for example, would you put savings away at 3%, yet pay 15% on your credit card?
So long as your credit card or personal loan interest rate is greater than your savings account interest rate, it will always be better to put your money towards paying off your credit card or paying down your personal loan.
Click Here to read my article on “Is It Good To Pay Off Credit Cards Right Away?”
If your credit card and personal loan debt is stressing you out and hanging around like a bad smell, then it’s probably best to just go to town on paying off your debt as fast as possible. Get it out of your life. Then you can laser focus in on your savings.
Not everything should be looked at from a financial sense, because spending all of our time paying off our loans can be very boring, uninspiring and demotivating, can’t it?
Life can get depressing if all we are doing is working our butts off to pay down debt.
From a psychological perspective, sometimes it can be better to save towards a goal (such as a new car, home deposit, etc.) while simultaneously paying off your credit card balance. This way, you can be saving towards something fulfilling and exciting – keeping you financially motivated – while also getting on top of your debt and making sure it doesn’t escalate out of control.
If you’re going to take this approach – save and pay off your loans – then you should definitely be putting in place a plan for both.
What you need to do is come up with a precise date that you want all of your credit card balance to be paid off and figure out how much you need to put towards it each week for it to be eliminated by that date.
Click here for a basic calculator to help you figure out the weekly repayments you should make.
Now, because you’ll be saving for a goal at the same time as paying off your credit card, then you should also be figuring out how much you need to achieve your goal and what amount needs to be put away in savings each week to achieve it.
This might take a little bit of balancing between what you can afford to pay towards your savings and your credit card each week.
Paying Off Credit Card and Saving
Let me show you an example of how this may work and you can use the same approach and apply it to your personal situation, your credit card balance, and your goals.
We will assume you have a credit card balance of $3,500 and the interest rate on your credit card is 18%
Let’s also assume that you want to go on a $2,000 local family holiday in 12 months’ time and refurnish your home at a cost of $2,500 in 2 years’ time.
Let’s say you are able to save $400 per month.
If you focused solely on paying off your credit card and then began saving for your goals, you would not have enough money to go on your family holiday, because (using this calculator) you will have only just paid off your credit card in 12 months’ time if you transferred all of your $400 savings towards the credit card each month.
So, how do you have your cake and eat it too?
Well, in the example above, if you were to save $165 per month towards your family holiday, $105 per month to your new home furnishings and the remaining $130 to pay off your credit card, you would be able to achieve the following:
$2,500 in 2 years’ time for new home furnishings
Credit card full repaid in less than 3 years
This same strategy can be applied to any debt levels, savings capacity and goal amounts. It’s all about doing some simple balancing and breaking it down into weekly or monthly repayments and savings.
Paying off credit cards, personal loans and other debt, while simultaneously saving on the side, will result in more credit card interest being paid and will not be as financially beneficial as eliminating debt as soon as possible, compared to saving. But the same argument could be made with a home mortgage really, couldn’t it? You’re not exactly going to hold off on any holidays or new cars until your home loan is fully paid, are you? I mean your mortgage might have an interest rate of only 5%, considerably lower than a credit card, but it’s still the same principle. So, keep this in mind when you are tossing up whether to pay off your credit card vs saving.
Click here to read my article on “Why You Should Never Fix Your Home Mortgage”
Any basic household budget should cater for all of this – your everyday expenses, mortgage repayments, credit card repayments, car loans, weekly allowances and savings for goals. Above all, it should be simple and easy to manage.
A Budget Is Telling Your Money Where To Go Instead Of Wondering Where It Went
– Dave Ramsey
Comment below and let me know if you pay down debt or build savings first. I’d be interested to hear.