Pay Debt and Save Money? Yes, You Can!
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The question is always the same. Should I pay off debt before saving or should I save money and pay off debt?
You can do both, and here’s why. And how.
Scenario 1
Let’s say you have a credit card with a $10,000 balance. You’re making minimum payments of $200 a month. You have no money saved for an unexpected expense.
Then you need to replace your hot water tank. It costs $1000. You put that on your credit card, increasing the balance to $11,000. Your monthly payment goes up to $220 a month.
Now let’s suppose you get a refund of $2000 from the IRS. You put the entire $2000 toward your credit card, bringing down the balance to $9000.
Then a medical bill that you forgot about shows up. It’s $500. You put that on your credit card. Now your balance is $9500.
Do you see where this is going?
Even though you’re making monthly payments on your debt, you keep adding to it which keeps you in a perpetual cycle of debt. When will it end?
Scenario 2
You have a $10,000 balance on your credit card and make the minimum payment of $200 a month toward the debt.
You receive an IRS refund of $2000 and put the entire amount into your high-yield savings account, earning 3.7% a month in interest.
Your hot water tank needs to be replaced and it costs $1000. Instead of reaching for your credit card, you use your savings and pay cash.
You continue making payments on your credit card, bringing the balance down little by little.
Then you get an unexpected medical bill in the mail for $500. You go into your savings and pay from that.
Your savings is now down to $500, but your credit card balance is going down as well.
But you’re still making minimum payments on your credit card and you’re down to your last $500 in savings. That’s better than the first scenario, but you could be doing better. Keep reading!
Scenario 3
You have a $10,000 balance on your credit card. The minimum payment is $200 but you add $50 more, making your payment $250.
You receive an IRS refund of $2000 and put the entire amount into your high-yield savings account, earning 3.7% a month in interest. You’ve also been depositing $50 a month into this savings account.
Your hot water tank needs to be replaced and it costs $1000. Instead of reaching for your credit card, you use your savings and pay cash.
You continue making payments on your credit card, bringing the balance down bit by bit.
Then you get an unexpected medical bill in the mail for $500. You go into your savings and pay from that.
Your savings is down, but that’s OK because 1) you didn’t add to your credit card debt and 2) your regular monthly deposits into savings will be replenished. Yay!
Go Further
Want to turbocharge your savings and investments, while also being strategic about how you pay off your debt? Let’s go!
- Call the credit card company and request a reduced interest rate. Here’s a script: “Hello, I’ve been a customer of [credit card company] since [date] and my interest rate is [X]. I’ve paid my card on time since I opened my account. I’d like to know if you can give me a better interest rate.” In some cases, they may give you a temporary reduction in the interest rate or even refund the previous month’s interest payment. If you’re not happy with what they tell you, ask to speak to a supervisor. If the supervisor is no help, thank them and call back on a different day. You may have better look with the second, third or even fourth, person. Always remain polite.
- Regardless of the answer, stop using the cards. Coming up with a plan, but continuing to use the cards won’t get your balances down.
- Use an online calculator, such as Calculator.net to play with different scenarios and see how much more you need to pay on top of the minimum payment and to see how much time it will take to pay off your card.
- Go to your payroll department and request a direct deposit to your high-yield savings account. These days employers are able to direct deposit your payroll into more than one account. This will help you build savings quickly. Start out with $25 per pay period, then double it and increase the amount every few months.
- Continue contributing to your employer-sponsored plan. DO NOT reduce contributions.
- If you don’t have an employer-sponsored plan, open a Roth IRA. Set up automatic transfers to your Roth each time you get paid.
Multiple Debt Payoff Strategy
When you have more than one debt, it can be tricky to figure out a plan to pay it off. The most common methods are the snowball and avalanche methods. Here’s how they work: with the snowball method, list your debt from small to largest balance. The idea is to reduce the NUMBER of debts. This is said to be motivating because you’re getting rid of the smaller debts first and fast. With the avalanche method, you list your debt from highest to lowest interest rate. This method saves you money on interest.
With both methods, you pay more than the minimum payment on the first debt and pay the minimum on the rest of the debts. Once that first debt is out of the way, you take whatever you were throwing at it and ADD it to the next debt (which you making minimum payments on). See the chart below to see how this works.
Don’t feel like you have to commit to one method if it’s not working for you. Some people start off with one method and decide to switch. If you have a number of debts, maybe you’ll start off with the snowball method to get a bunch of them out of the way. Then you can switch to the avalanche method, which will save on interest!
And meanwhile, keep up with your savings.
If you’ve tried this and have any tips, feel free to leave a comment below!
Sometimes you may feel like you want more help and someone to hold you accountable. If that’s you, check out my 1:1 private coaching program. Together we’ll do more than just create a plan to pay off debt. Schedule a strategy call today!
