I’ve been working for a few years now (graduating in 2014) and have a decent mutual fund ($9,000), savings account ($9,000) and a Roth IRA ($10,000) because my current company is not a 401(k). But I do have credit card debt ($9,000) and student loans to pay off. Should I use my savings to pay off my credit card debt? – Erin
“This question comes up all the time,” said Angela Coleman, a certified financial planner and fiduciary investment advisor at Unified Trust Company.
But that doesn’t mean there is one right answer.
People who have no tolerance for debt, such as radio host and author Dave Ramsey, will tell you to take everything except $1,000 dollars and throw it on that blame. Others will tell you to keep your emergency piggy bank and set a budget to pay off the debt.
While no money mind can tell you exactly how much of your savings to spend on debt, they can help you think about how to arrive at the right answer for you.
“After people look at all the factors — retirement goals, savings levels, amount of debt — it comes down to what you can live with,” Coleman says. “Once you’ve analyzed everything to death, it’s your decision and you should feel comfortable with your choice. That’s important.”
You know what else is important? An emergency fund. That’s where you start your decision-making process.
This is Coleman’s path to coming to a clearer understanding of your options for using your savings to pay off debt.
How’s your emergency fund going?
“Emergency savings are always a must,” Coleman says. “We usually recommend setting aside about three months’ worth of expenses in savings.”
So add up all your essential monthly expenses – rent, utilities, food, etc. and multiply that by three. You always need at least that amount of savings.
Without knowing how much Erin earns, we don’t know if her savings equals three months or a month, but we assume it’s at least a few months of expenses.
“It’s great that she saved so much. Still, she probably doesn’t want to use it all at once,” Coleman says. “Maybe it makes more sense to pay off half of the credit card and focus her efforts on paying off the rest rather than building her savings.”
What is the interest on the debt?
We don’t know much about student debt (how much? at what interest?), but some federal student loans are often considered “good debt” at relatively low interest rates. But credit card debt is a different story. The average interest on credit cards is around 15%. Meanwhile, savings accounts typically pay about 0.01%.
“If she’s paying 15%-20% interest when the money in the savings is doing nothing, that’s not good,” Coleman says.
Considering how much high-yield debt will cost you compared to how little you’re likely to make on cash, you might as well use some of it to pay off the debt.
How about getting rid of that interest?
Debt is one thing, but the rising interest payments on that debt can cause paralysis.
“Another strategy is a 0% interest card,” Coleman says. “You can transfer a balance to a card on which you pay no interest and save yourself some of the costs.”
These are called balance transfer cards. The promotional 0% interest rate can be a huge relief, but it’s only for a limited time, usually nine to 21 months. The real question here is: Can you pay off $9,000 in debt in that time?
“That’s usually a better strategy over a shorter period of time,” Coleman says. “It’s a loan to extend the debt, so there’s no need to pay the lump sum of your savings today.”
Still, she adds, you should be careful when paying off one credit card with another.
“Make sure you pay it off aggressively during the set time because at the end, if you still have a balance, you could have an even higher interest rate.”
Is this debt keeping you up at night?
If so, you might as well take the Dave Ramsey method and pay off that debt in one fell swoop.
If it’s not giving you seizures — and chances are it isn’t because $9,000 in credit card debt doesn’t arise overnight — a good plan is to leave your savings alone and add nothing more to it. until the guilt is clear.
“I’d suggest rolling back the savings,” Coleman says. “If she can channel all the money she’s putting aside for savings and push it toward debt payments, that would be a good plan.”
But keep up the good work on the retirement front, adds Coleman.
“I wouldn’t suggest she pull out retirement savings altogether,” she says. “That’s important because she doesn’t have a 401(k) at work. It’s good that she was able to put money away. It will benefit her a lot in the future.”
What is the best plan for you?
There are several options.
You could use anything but $1,000 to pay off the debt. You could be putting a good chunk of your savings into debt. You can transfer the debt to a card with a 0% short-term interest rate. You could just turn all the money that went into savings into paying off debt. Or a combination of these options.
But remember, Coleman says, “Beginning is so much more important than what you start with.”
Whether you’re throwing lump sums at the credit cards or simply making larger debt payments than before, getting started eliminating that debt is the most important thing.
Do you have a question about Money Moves? Ask us here to be included in a future column.
CNN Money (New York) First published February 15, 2018: 12:25 PM ET
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