Is It Better to Save or Pay Off Debt?
A reader asks: We've been working on paying off our credit cards and have about $1,300 dollars left. We are currently looking at a possible $2,000 car repair or buying a new car depending on potential engine damage. I’m wondering if we should increase our credit card debt or deplete our saved resources to pay this bill. We have about two months of every budgeted bill saved up and no other savings. Should we use this money or add to our debt?
To Pay Off Debt or Keep Money in Savings?
At first glance, the answer may seem obvious. We save money specifically to help manage those unexpected, rainy day expenses. And when the car breaks down, that seems like a pretty rainy day, right?
In reality, the answer is a little more complex. After working so hard to pay off your credit card debts, you may not be inclined to lose all that great progress, but once you use up your savings, it's gone (until you can build it back up again). And while you'd hope that today's car problems are the worst thing you'll have to deal with in the immediate future, there's no guarantee that another unexpected expenses isn't just around the corner.
So while there's no right or wrong answer, there are a few questions you can ask yourself to make sure you're making the best choice for your situation.
Considerations for Using Up Savings vs. Adding More Debt
Are there bills you can't pay with credit?
The top priority for your emergency savings account is ensuring that your basic needs are met even in the event that your income is cut off. When thinking about the most important bills in your budget (mortgage, rent, electricity, food, etc.) it may be helpful to determine which can be paid with credit and which cannot.
If a sizeable portion of your most important monthly expenses can't be put on a credit card, you may want to make sure that you've always got enough in savings to handle those payments at least.
How much is your new debt going to cost you?
Carrying debt wouldn't be such a big deal if it wasn't so expensive. The biggest factor in the ultimate cost of a new debt may be the interest rate of the credit card you're using to make the payment.
A card with a favorable rate may make using credit card and maintaining your savings preferable, since the interest charges will likely be manageable. But if your credit options all come with big interest rates, that may a reason to consider using your savings instead.
How comfortable are you going to feel operating without a financial safety net?
Leaving aside the dollars and cents, you know you better than anyone else. So consider your own feelings, values, and priorities. Would you feel comfortable moving forward without those emergency savings? Would backsliding into more debt be a real blow to your morale?
Everyone has a different relationship with money. Some people need deep cash reserves to feel safe, and some feel pretty confident that they can make it work no matter what. Be honest with yourself and let your heart have a say in the matter.
And if you need a little more personalized advice, MMI offers free, confidential financial counseling. We'll review your bills, your debts, and your goals and help you start making the best money decisions for you and your family.
