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Paying Off The Credit Card or Saving?

This is the one time in your life where it is not good to save! It is almost always better to pay off debt. Whether it be credit card debt, a personal loan or a mortgage. Anything that attracts interest should be paid off over saving. Let me illustrate this budget tip with an example.

Say someone has $10,000 of credit card debt and have $10,000 of savings. Now on the savings they get a healthy 7%. That is $700 a year, not too bad. But after you take tax out at 33%, you are left with just 4.7% or $470.

Now on the other side of the coin. When you pay the interest on your credit card it is of course paid with after tax dollars. At an interest rate of 19% that costs $1,900 a year. Now let’s not forget that is with after tax dollars!

If you compare the after tax return of $470 with the $1,900 after tax interest cost of paying interest on the credit card it just does not make sense. Why would you be happy earning $470 interest when you are paying $1,900 on your credit card? You would be $1,430 worse off per year! It would be better to just pay off the credit card.

There are some instances where saving might be preferable to paying off debt. One is to have a buffer or reserve of savings for emergencies. This is discussed in the “How Important is Saving?” article. Having a ready supply of cash gives you flexibility and choices when something sudden may change in your life. Alternatively you may need the savings for a house deposit or something similar. In this case you have little choice as you will probably need the savings.

In most cases it is better to pay off debt than save. It’s pretty simple as you will be earning less interest than what you will be paying on your debt. So first priority, get rid of those debts! Paying down debts again comes back to budgeting. Setting up the right budgeting system, building the right habits and then making it happen.

 
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