Don’t Hang on to Credit Card Debt

Hanging on to debt is like a disease that you would rather not treat right now and in the end pay (or not) for it by filing for bankruptcy. We think we need to carry a balance on our credit cards and make minimum payments even though we could pay it off. The hidden cost of debt is the interest which is so implicit that the good folks in the Government decided to make it part of the credit card reform.

Dealing with tax payers day in and day out, I see how must of them are in a financial hole since they complain about how they are indebted to everyone, from banks to friends. Even though the pundits have tricked you into believing that there are two kinds of debt, good and bad, I would argue that when you pay insane amount of money in order to get access to more money then it is all bad. Think I am crazy? Ask the person trying to pay off a credit card who can only afford to pay the minimum…

The most common reason people give me for having money in the savings account when they have pile high credit card debt is because they consider their savings account as a rainy day fund. Instead of having money in savings account paying less than 1% (these days), trying paying off your debt. The national average on credit card interest rate is currently 14.35%. (Source: CreditCards.com)

Rainy day fund is a good idea, in fact it is a great idea but you should do the math to calculate if it is worth it. Here is one example:

John Doe has $5,000 in credit card debt and $10,000 in savings. Interest rate on his credit card is 14%, or $700, but the $10,000 in savings earns just 2% annually, or $200. He could pay off the debt, saving the $700, and still earn $100 annually on the remaining $5,000 in savings.

Do you see what is happening in this example? It doesn’t make sense for you to keep more money in your savings account even though your credit card debt is lower and you can use the money from savings account to pay off the credit card. Don’t divide your money by doing mental accounting, in most cases you will not benefit.

Before you start an emergency fund, pay off your debt and then I guarantee you will save more and faster than you previously did.