When its Not Better to Pay off All Debt
Posted on January 18th, 2009
Most people automatically assume that the sooner they pay off their debts, the better off they will be financially. This theory doesn’t always prove to be true. Actually, when you save money in the bank, you are loaning your cash to the bank. This can allow the banks to give other consumers borrowing power. The bank makes a profit from this by using the difference between the rate that it borrows money from you, which we know as the savings rate, and the rather that it charges others, which is the borrowing rate. This actually results in costing you more money to borrow, then to save.
It is important to look into all of your options when looking to pay off debts, because there are a small number of instances when then debts equal out to be cheaper than the savings do. Or in some cases it may cost as much to pay off your balance as it would to save.
Case #1.) Interest Free:
There are some people who manage their debt properly by switching their debt to interest free accounts. These people want to take the time to look at what their savings account interest will earn them after tax, versus what their interest rate is. If your interest rate is lower than your savings rate, then you can actually benefit from building your savings and keeping your debt. The result will make you profit on the money that is borrowed to you by the banks.
Case #2.) Penalties:
Always check into whether or not your debt will incur a penalty if you pay it off too soon. Some loans or mortgages will actually charge a penalty if the amount of the loan is paid off in a certain time frame. Keep in mind that if you keep that money in your savings account, where it can earn more interest, you will be better off. Keeping the money and waiting until your penalty is waived or not in effect anymore is the better way to go.
Case #3.) Emergency Reasons:
In the case that you don’t have a large amount of debt, it is always a good idea to have something like an emergency cash fund in the bank. This however isn’t true when you are a person who is suffering with many credit card debts and are possibly in over your head. If this is the case, then it is more beneficial to you to go ahead and use what is in your savings to pay down on your debt. This will help you eliminate the high interest that you may be gaining on your balance month after month. Even if you are in over your head with credit cards and happen to pay them down, don’t immediately cut them up. Because you have more than likely used your savings to pay these cards, keep them in case of emergency. If there is a home, car or some other type of emergency that you may have to pay for, they will be beneficial to have.
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