Should I pay off my credit card or save money?

pay off debt or save

By Donna Freedman

Should you pay off your credit card bill or save money first? That depends.

On one hand, making bigger credit card payments reduces the amount of total interest you’ll pay. According to Experian, the average credit card balance as of June 2019 was $6,194.

On the other hand, not having an emergency savings fund leaves you vulnerable. Suppose your hours get cut at work, or you lose your job altogether. Without a cash buffer it could be hard to pay the rent. (Hint: Most landlords don’t take credit cards.)

So why not do both? A mix of debt payoff and saving lets you address both issues, without being caught cash-less in the event of a work slowdown or some other emergency.

Why credit card debt matters

Beverly Harzog, the credit expert at U.S. News & World Report, calls credit card debt “toxic debt.” It tends to carry a much higher interest rate than, say, mortgage debt – and you won’t end up with a house at the end of the repayment. The longer you delay credit card payoff, the harder it will be.

“If you only pay the minimum, the debt gets bigger and bigger,” says Harzog, author of “The Debt Escape Plan.

How to slay the debt dragon? Every situation is different, but all solutions should start like this:

  • Track your spending – on paper or with free budgeting software – so you can plug any leaks. (For example, you may not realize how much you’re spending on food away from home.)
  • Go through your household budget and look for ways to cut back temporarily.
  • Figure out how much you’ll have after paying rent and other bills, and making those short-term cutbacks. Then get ready to make extra payments, above just the minimum payment.

How much extra? That depends on your circumstances and your disposable income. Here are a few broad examples:

You have some debt with a moderate APR, and no savings.

Suppose you’ve got $200 in extra cash each month after bills and daily expenses. Put an extra $100 against your credit card debt and the other $100 into an emergency fund savings account.

You have some debt with a moderate APR, and some savings.

Having even some money in an emergency fund lets you be a bit more aggressive about paying off the credit card. Put $150 of that $200 against the debt and $50 in savings.

You have lots of debt, a very high APR and no savings.

High-interest debt is costing you a bundle. Suppose you had a $2,000 credit card balance on a 15% APR card, and normally paid $40 a month. By the time it’s paid off, you’ll have paid $1,026 worth of interest – more than half the original balance!

Now suppose you raised the minimum payments:

At $75 a month: $412 total interest
At $100 a month: $291 total interest
At $150 a month: $187 total interest
At $200 a month: $138 total interest

In other words: By adding $35 to $160 a month to the $40 minimum you’d been paying, you would save anywhere from $614 to $888 in interest!

That’s why in a case like this Harzog recommends focusing on repayment only for six months. Otherwise, she says, the debt is “just going to get worse.”

Bonus? If your financial goals include improving your credit, reducing your debt faster could help your credit score. By paying down debt, you reduce your "credit utilization ratio," which is a major factor in your credit score.

Which card to pay off debt on first?

If you’ve got debt on more than one credit card, some experts recommend the “debt snowball” method: concentrating on the one with the lowest balance and making the minimum payments on any other card(s). Once the low-balance card is paid off, you focus on the card with the next-lowest balance.

There’s also the “debt avalanche” method: concentrating on the card with the highest interest rate even it if has the lowest balance, because it saves you more overall. However, fans of the snowball method say that paying one card in full can motivate debtors to keep going – and that’s worth a little extra interest paid.

Decide what works best for you. Maybe a quick victory would motivate you more to pay off debt than doing the math on the interest paid on a higher-APR card.

And if you’re concerned about savings not building quickly enough? Remember that once your card is paid off, all the money you’d have been paying in interest can go into your emergency fund.

How big should your rainy day fund be?

The standard advice has been to have at least three months’ worth of household expenses saved, although some personal finance experts recommend six to 12 months’ worth.

A new joint research project, based on income and expenses from 70,000 low-income U.S. households, came up with a brand-new figure: $2,467. The study, from the University of Colorado and the Universidad Diego Portales in Chile, suggests that this recommended emergency fund size is enough to cover most issues facing an average household.

However, saving nearly $2,500 – let alone up to a year’s worth of living expenses – can seem impossible to people in their 20s and 30s, especially those with student loans. Some might feel defeated before they even start.

That’s why Delia Fernandez, a certified financial planner in Los Alamitos, California, suggests a $500 emergency fund as a compromise.

“The general advice of three to six months’ expenses? Not a lot of young people can do that,” she says.

How to save $500 in six months

Break it down: That’s about $2.77 per day for 180 days.

How to find the extra money in the budget varies from person to person. Commuters could use an app like Gas Buddy to get the lowest price on fuel (small savings add up). If you’re not already packing a lunch, start doing this at least three days a week; bring coffee or tea from home, too. Instead of going out every Friday or Saturday night, cut back to twice a month.

“You need to be crystal clear about your wants and your needs,” Fernandez says. “You can have anything in the world you want, but you can’t have everything.”

Another option is to earn more. Ask for a raise. Pick up extra hours at work, if you can. Sell unused items through consignment shops (virtual or brick-and-mortar), or through sites like OfferUp.com or LetGo.com. Look for an occasional side gig like house-sitting, dog walking or babysitting. The SideHusl.com site lists scores of earning opportunities, along with the pros and cons of each one.

What about a balance transfer or debt consolidation?

If you have a good credit score you might qualify for a 0% APR balance transfer credit card. The best current deals feature that introductory APR for 12 to 21 months, according to Harzog. Once the balance has been transferred, the money you had been paying in interest can go toward the debt.

These cards can be a good deal if you factor in the transfer fee – and if you have an ironclad plan for paying it off on time. Otherwise, you’ll be back to paying interest.

Debt consolidation, through a debt consolidation loan or a debt settlement company, can help some consumers get back on track. But not everyone is eligible, and debt settlement may affect your credit score. In addition, shady “debt relief” schemes abound on the Internet.

Before you decide, make an appointment with a credit counseling agency. Find a reputable agency through the National Foundation for Credit Counseling or through a consumer protection agency, a university, the U.S. Cooperative Extension Service, a military base, your local housing authority, or a credit union or financial institution.

The bottom line

Debt can derail your finances, both now and in the future. Every dollar you pay in unnecessary interest is a dollar that can’t work for you later on.

Paying off credit card debt is essential. But so is building an emergency fund, in order to maintain a debt-free life. This one-two combination will help you build a secure financial future.

About the author

Longtime personal finance writer Donna Freedman lives and writes in Anchorage, Alaska.

Written on November 27, 2019

Self is a venture-backed startup that helps people build credit and savings.
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Disclaimer: Self is not providing financial advice. The content presented does not reflect the view of the Issuing Banks and is presented for general education and informational purposes only. Please consult with a qualified professional for financial advice.

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