Should savings be applied to card debt?

By UK CreditCards.com

If you have savings and credit card debt at the same time, you wonder if the wisest thing to do would be to pay off the debt. Typically, the answer would be "yes," but not until you have an emergency savings fund set up.

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First of all, congratulations on having savings. In this economy, with downsizing and layoffs common, savings are essential. Ideally, you should have enough savings to live off for three to six months should you find yourself out of work.

Know your own spending and consumption habits in order to determine what a month's living expenses should be for you. If you find yourself out of work, then naturally, you'll cut back on your non-essential spending during that time. But if you make your theoretical emergency budget unrealistically austere, you could burn through your savings faster than you expect. Plan to be frugal, but be realistic, too.

Once you have three to six months stashed in your rainy-day fund, it's a great time to put any new extra income toward paying off your credit cards. Credit cards can easily carry interest rates of 20 per cent or more. If you had an investment that was paying you 21 per cent interest per year, then perhaps you could justify not paying down your cards, but even the luckiest stock traders can't get that kind of return. So it's only logical to put any extra cash toward those balances.

Some experts suggest paying off the credit card with the highest interest rate first, on the theory that you're saving the most money in the long run by doing so. Others suggest paying off the smallest balance first and putting the card away in a drawer, on the reasoning that paying off one card will motivate you to tackle the next biggest balance, and so on.

Unless you have one credit card with an interest rate that is far above that of the others, then it probably doesn't make that much difference which one you pay off first. While some financial gurus say to only keep one credit card, two is better. Why? Imagine you're out of town on vacation or on business, and for some reason your card is declined when you're paying for a hotel or a meal. You need a backup so you're not left in a difficult and awkward situation.

Using your savings to pay off credit card debt is a great idea, as long as you don't raid your emergency fund to do it. Once you have emergency savings enough to live off for three to six months, that's when you should start putting extra cash toward paying down those balances.

Published: 24 September 2010