October 8, 2006
Why save when you’re Broke
Why do people have a savings account when you’re in big time debt? When I used to work at a bank in Atlanta, I used to see thousands of people that had a savings account (earning 1.5% interest) and a maxed out credit card with an interest rate of 15% or more. This makes no sense at all. When you have an interest rate that is higher than the savings rate, you need to lower down your credit card balances before you save. Some people think that having an emergency fund is worth having even though you are in debt. I don’t really think that is true.
Example: You have $2000 of credit card debt (14% interest
You have $2000 in a savings account (4% interest)
Credit card monthly payment is $40.00
Total interest paid monthly ~$22.00
Savings account interest yearly payment is $80.00.
Monthly interest ~$6.00
Total loss of $16.00 per month or $192.00 per year.
Now just look at the figures. As you can see that is a difference of 10%. If that doesn’t turn you away maybe this will. Your income on that 4% is taxed, while the credit card debt is not tax deductible. This kind of situation you are being penalized to save. Pay off your balances then save.
After you pay off your credit cards then you can start pumping money in your emergency fund. If a situation does end up coming up and you don’t have any money in savings then use your credit cards to save the day again. Yes, you will be in the same situation as before, but you will still be saving a lot more money by paying credit cards off first.
If you are currently in this position don’t feel bad. I’ve been looking around many financial blogs and there are tons of people doing it. *including some authors that run the blogs?!?*
Great Calculators
My guess is that it feels safer to have cash in the bank and tons of debt than to have no cash and slightly less debt - if something goes wrong and your CC is virtually (or actually) maxed out, how are you going to pay for anything? At least by having some cash saved up, you have the ability to pay for any extremely urgent things that are needed (food/gas/etc) if needed even if you can’t pay off the credit card bill. I’ve always tried to avoid debt (other than student loans and a mortgage recently) so I don’t carry a balance on my CC - so I can’t speak from experience on this one, but that is my guess.
Well the scenario you speak of is a little different. I am saying that your CC wouldn’t be maxed out if you didn’t have savings, but lets just say you did have your CC maxed out and you didn’t have any cash and you needed money fast. The situation would totally change because these means that you have been totally overspending which means you wouldn’t really have a savings account so you didn’t have cash anyways.
I’ve gotten in some pretty sticky situations, but never to the level of total overspending (which usually means you are spending over 120% of what you make after taxes). It would be very rare that a CC company would even allow you to have credit in the first place if you were already in so much debt. I would try to transfer the balance and stick with cash till you have all your debt paid off.
Many of the bloggers (and myself) who have both CCs and savings accounts are borrowing money at teaser 0% rates and investing it in highyield savings accounts for an easy 5% arbitrage. Or, they have a balance in the card they use for purchases but it is still in the grace period. Either way, they are earning interest and not paying any.
Yeah I realize that. I am only referring to credit card debt that has higher interest rates. I said over the savings rates is usually a bad decision because you’re losing cash and there are bad taxes to deal with(interest tax on the savings). I would say anything under 7% on a credit card balance transfer is fine by me. Over that I would look at a new game plan.