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Guru Q&A: Should I Pay My Credit Card Off With My Savings?
FiLife User Question: I have a credit card with a balance of $5,000 and I have enough money in my savings account to pay this off. Should I go ahead and pay this off so I have more money during the month to live on because it is difficult some months to make ends meet.
-unicorn
FiLife Guru Response: Generally speaking, I think this is a good idea. Here are some things people in situations like yours might consider.
-What is the interest rate on your card? If it’s like most cards, the rate is somewhere between 12 and 30 percent. Assuming that’s true, then paying off that card is almost surely the best investment you can make in your financial future. The interest you’re paying won’t be tax deductible, and so if you have a 20% rate, paying it off will be like “earning” 20% on that money, tax free.
-What is your credit limit on the card? If your limit is less than double the debt on the card–under $10,000 in your case–then paying off the card will likely result in a substantial boost in your credit score. That can save you money not just on home and car loans, but on other products where credit score may be a factor, such as your insurance policies. In such circumstances, improving your credit score becomes another strong argument for paying off or at least paying down your credit card debt.
-Do you have access to other funds in the event of an emergency? It’s always a good idea to have an emergency fund to cover unexpected car repair, an sudden illness, or other unforeseen necessity. The best argument for NOT paying off your card right away is if you have no other emergency funds to tap in the event something like this happens to you. For this reason, many financial advisers suggest having three to 12 months’ worth of living expenses in a savings account before paying down debt. However, I would argue that other sources of funds can fill this role, and that in a case like yours they potentially should. If you have ready access to other money, which could include parental help, available credit on a home equity line of credit, or contributions to a Roth IRA (which are penalty- and tax-free when withdrawn), then having extra money sitting in a savings account isn’t as critical.
-What is your retirement savings situation? Depending on your job, you may qualify for matching 401(k) contributions from your employer. Depending on your income, you may be eligible for the Saver’s Tax Credit. If you can capture one or both of these credits by saving for retirement–and you wouldn’t be able to manage this and pay off your credit card debt at the time time–then it will likely make sense to capture this matched money first.
I hope that helps. Feel free to follow up with specifics.
-FiLife Guru Dave Hanson
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(2) Comments
You may want to consider getting a new credit card with a 12-month 0% balance transfer rate and low transfer fees. Then, transfer your debt to the new card and continue paying it off. In the meantime, you’ll continue to make a modest sum on interest from your savings. Keeping that kind of debt on a credit card for more than a month or two at a time is almost never a good idea.
Thank you for the comment CSE!
I agree that used properly, an promotional rate balance transfer offer is a powerful tool in the financial toolkit.
The reason I didn’t mention this idea in the original reply is that anymore, on a $5,000 transfer, it’s almost never worthwhile to use an introductory balance transfer promotion. That’s because even the “capped fee” offers will charge a fee of $99 or more to do the transfer, and even those are very hard to find. Meanwhile, unicorn will have a new inquiry and new credit line showing on their credit report; will have to execute the promotional offer perfectly so as not to lose the rate; and in this environment will be very lucky to get a 12-month, 0% offer to boot.
Bottom line: while it won’t hurt to look into it, I’m doubtful that it will prove worth the tradeoff in effort, risk, and credit impact here when simply using savings is an option. Especially in other cases though, it may be a great option.