With the average U.S. household carrying $15,762 in credit card debt, many people are looking for the best way to manage it1. Although there isn’t a cut and dry answer, you can follow a few guidelines to help make things easier. Credit card debt doesn’t have to be a nuisance if you know how to properly tackle your monthly payments. Let’s explore the possibility of using savings to pay off debt.
Question: What is the Best Way to Pay Credit Card Debt?
It’s important to carefully manage your credit card debt so it doesn’t get out of control. Let’s assume you have some disposable income at the end of the month and you have the option of either paying off your credit card or making a deposit into your savings account. Conventional wisdom says that effective credit card debt management is far more beneficial than depositing funds into a low-interest savings account2. That's because the amount of interest you would pay towards credit card debt is likely much higher than the interest you would earn from your savings2.
Would you like to see your credit score now? YES, SHOW ME MY CREDIT SCORE
Make sure that you have enough money saved for emergencies so that you don’t drive up more debt if and when the need arises. A good ballpark for a basic emergency fund can be around $1,000 but it can vary depending on your income level. Once you’ve put that aside, focus all your excess disposable income (the money you have available after taxes have been taken out of your paycheck) on paying down your debt.
Question: Should You Use your Emergency Fund to Pay off Credit Card Debt?
Let’s say that you have $15,000 in credit card debt and $15,000 in savings, should you take the money from your savings account to pay down your credit card debt? Bear in mind that the interest earned on your savings account is most likely going to be less than the interest on your credit card, so it stands to reason that by not taking decisive action, your net worth may slowly erode away. Depending on the interest rate, however, your approach may differ.
The general rule of thumb is that the higher the credit card interest rate, the more necessary it becomes to pay down that debt, and using your savings account may be a step in the right direction. If you have $15,000 in credit card debt and an equivalent amount in your savings account, it would make sense to use a portion of the money in your savings account to pay your credit card debt down to a manageable level. Maintaining your credit utilization ratio, or the amount of balance you carry versus your limit, could keep your credit manageable. That means if you had $15,000 of credit card debt, you’d want to pay down at least 70 percent of that, or $10,500. As your income allows, pay off that additional $4,500 as quickly as possible to avoid additional interest.
Question: How Can You Strike a Balance Between Credit Card Debt and Savings?
A balanced approach is also a sensible one to adopt. The seemingly competing objectives of increasing your savings or paying down your credit card debt do not have to be mutually exclusive. It may be helpful to attempt to strike the right balance between an emergency nest egg in your savings account and manageable credit card debt.
It’s true that credit card interest payments are typically higher than the interest earned on savings, but it may be shortsighted to use all your savings to pay off credit card debt. If you’re not careful, you could end up driving your up debt again in the event of a life change or emergency without the safety net of savings3. The golden rule is to strike a balance between a comfortable stash in your savings account and a manageable level of credit card debt.