Hal wrote to me through the GetOutOfDebt.org site and asked the following question. If you have a credit or debt question you’d like to ask just use the online form. I’m happy to help you totally for free.
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“Dear Steve,
I have an outstanding credit card balance of $ 8,288.76 at 18.99% APR. We are paying roughly $500 a month, which is about 300 over the minimum. However, the finance charges costs about $138, seems to me to be a losing battle. I have 13K in a savings account that is making just over 1.3% interest. Just about 9k should cover 3 months worth of expenses.
I want to know, what many others seem to want to know…Should I pay off the card which costs me ~$130 a month in interest with money from my savings that earns me about ~$70 a year if lucky? The monthly credit card payment would then be applied back to the savings account to rebuild that.
Most of your past advice seems to lean towards keeping the savings…are there any situations in which you would recommend paying off the credit card if this is not one such case?
Hal”
The Answer:
Dear Hal,
I know, my position has been a perplexing conundrum. Mathematically, it does not make sense. But emotionally and prudently it is a better solution.
So let’s say that you do elect to wipe out the savings to pay off the high interest rate credit card. That leaves you out of debt (Ahhhh!) but without a safety net. So why is the safety net so important.
These days it is not unheard of to have a credit card issuer cancel a credit card. If you drain your savings and then are counting on the credit card to save you if you have a financial emergency, what happens if it is cancelled or interest rate raised even higher in the meantime?
If the savings is drained but the card is not cancelled and for some reason you are laid off or need supplemental cash where will you turn? Would you take cash advances from your card that is now paid off? The interest rate for those is sky high? And if you had to charge expenses just to get by, you are right back in debt again.
If you wanted to leave the savings at the level it is at, fine. Use all your available extra money to pay down the debt as you are.
Basically it all boils down to this. The interest you are paying is essentially an insurance policy that if some wild ass crap hit the fan for you you’d have cash in the bank to pay for it rather than drive you back or deeper into debt. Nobody ever found themselves in an emergency or accident with too much cash in savings.
If you are a risk taker by nature, you think I’m dead wrong, or you like math better than a safety net, do it.
Please update me on your progress by posting updates here in the comments section of your question. I’m very interested in how this works out for you.
P.S. Be sure to read ‘The Secret of Surviving Through Difficult Economic Times. What I Learned On My Journey‘.