So you’ve got a little bit of extra cash and are wondering how to make the best use of it. Should you put it toward your long suffering savings account, or follow the well-intentioned advice of family and pay off your credit cards? It’s an age-old question.
As it turns out, however, the answer isn’t so clear cut. There are pros and cons to each course of action, and as they say, every situation is unique.
To help you decide which choice might best fit your personal circumstances, here are four things to consider:
1. The pros of paying off credit card debt
Depending on the number of credit cards and the amount of debt you have, paying it off could make a lot of sense. Interest rates on balances carried each month are typically between 15 and 18 percent on an APR basis, and some can be much more.
If you carry a balance of say $4,000 on your cards, you could be paying more than $700 a year in interest charges alone.
That means paying off the entire amount owed on your cards will be an instant annual savings to you of at least $700, which you can then put into your savings account. In fact, you could simply make the same monthly payments you had been making – except that you would be paying yourself.
Now that’s a savings plan!
2. The cons of paying off credit card debt
Of course, nothing comes without a trade-off, right? If you choose to pay off your credit card debt all at once, there may be a natural tendency to begin accumulating debt again. After all, those cards are in your wallet and available, right? That’s where discipline comes into play.
Also, if you’re already strapped for cash, trying to pay off your entire credit card balance could leave you with very little money to meet other financial obligations.
Paying off credit card debt is a great idea, but only if you can avoid racking up debt all over again.
If you find yourself too deep in debt to get out on your own, consider working with a debt relief agency.
3. The pros of putting the money toward your savings
The advantage of adding to (or starting) a savings account is obvious. Any time you can earn interest instead of paying it to a creditor, you come out ahead. It’s also money that can help you in case of an emergency.
This has its own advantages because you wouldn’t have to borrow money in an emergency. You can just dip into your savings.
Having a savings also allows you to invest in things that may have a long-term positive impact on your life, such as starting a business or investing in yourself. It can also allow you to take advantage of opportunities that someone without available cash would miss out on.
4. The cons of putting the money toward your savings
This may seem counterintuitive to many of us, but there are actually times when putting money into a savings account doesn’t make a lot of sense. One of those times is when the interest rate on savings is so low – as it is in today’s economy.
Most savings account rates are well below 1 percent on an annual percentage yield basis. This means you will actually lose money if the rate of inflation exceeds that 1 percent rate.
In this case, you may be better off using your available cash to pay down any high-interest debt you have. By ridding yourself of debt, you are in effect saving at that same high rate of interest. The result is more of your monthly income staying in your pocket instead of going toward the creditors.
Hopefully we’ve helped you determine which course of action best suits your financial situation. Each of us gets to decide the best way to use our hard-earned money – but sometimes it helps to weigh the pros and cons.
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