Many times people in debt want to do everything possible to get out of debt as fast as they can. This usually leads to them wondering if they should be taking some of their savings to pay off some of their debt.
Unfortunately, many times this can backfire and cause more harm than good. But in some cases, it is a smart thing to do in order to get out of debt.
So when does it make sense to use savings to pay off debt and when does it not? Below you will find 4 scenarios that should make it clear when you should consider using savings to pay off debt.
4 Things To Think About Before Using Savings For Debt
#1. Will It Expose You To More Debt?
Many times taking savings and paying off debt isn’t a smart idea. The reason is because it exposes you to more debt. For example, let’s say you have $5,000 of debt and $2,000 in savings. If you use your savings to pay down your debt, you still are in debt of $3,000.
In addition to this, you now have no savings at all. What if something happens and you need money? Chances are you will have to use your credit card to cover it. Now you are back to a higher debt level and you have no savings at all.
I know you want to get rid of your debt quickly, but using your savings in this manner is only going to lead to more trouble.
#2. What Is The Interest Rate?
Another thing to think about is what is the interest rate on the debt? If it is around 3%, it is essentially interest free debt. This is because inflation averages 3% a year.
The lower your interest rate, the less you have to worry about how much more you will be paying in terms of interest. Of course you still want to get out of debt, but paying 3% in interest is a lot more tolerable than paying 14% interest.
#3. Is The Interest Tax Deductible?
In addition to a low interest rate, you need to know if the interest is tax deductible. If so, the true interest rate you are paying is lower than what it states since you can write off some of the interest on your taxes.
Again, I’m not suggesting you just carry debt for a tax write off, but having the ability to write off some of the interest does take away some of the pain of carrying the debt.
For example, my wife and I have a mortgage. We want to get rid of it quickly, but instead of paying extra each month, we put the extra money for the mortgage in a bond fund. This allows us to take advantage of the interest deduction on our taxes and still come away with paying off the mortgage early.
#4. Have You Gotten Your Spending Under Control?
Finally, before you even consider if you should use some savings to pay off debt, you need to be honest with yourself. Is your spending under control? In other words, are you going to start racking up more debt once you pay off your current debts or are you going to live debt free?
I know in an ideal world you will never get into debt again, but you have to be real with yourself. Is your spending really under control?
If it is not and you take savings to pay off debt, you are just going to end up back in debt with no savings at all. Much like the first point.
When You Should Use Savings To Pay Off Debt
All this leads to the safest time of when you should use savings to pay off debt. The safest time is when you have a small chunk of debt left and you have your spending under control.
At this point, you can take your savings and wipe out the remaining debt you have. The reason this is OK is because you can now move the money you were putting towards your debt every month into a savings account to quickly replenish it back to a safe level.
At the end of the day, you are better off not taking savings and putting it towards debt. There are just too many things that can go wrong. And when they go wrong, you will get depressed because you still have debt, and in some cases more debt, and no savings at all.
I would only recommend using savings for debt when you are at the very end of paying off your debt and can use the money you were putting towards debt to rebuild your savings.