When using savings to pay off debt is a good idea

Pete, I've got a question for you. I have $4,000 in savings, which is 3 months of expenses for me. I've also got just over $4,000 in credit card debt. $1,000 of which is Care Credit (interest free medical debt). I've always heard not to use savings to pay off debt, but after listening to Episode 3 of your podcast where you told Marissa to save up to $750 and then go after her debt with everything else I'm wondering if I should use some of my savings to knock out my credit card debt which is earning 16.99% in interest each month. Once the high interest credit card debt is paid off I can use the extra savings each month to build up my emergency fund. What do you think?

Rachel

Typically what I see is people who have credit card debt and no savings, but your situation is more unique since you have an equal amount in savings as you owe in debt.

I always recommend not using assets to pay off debt, mostly because of what it does to your net worth. Currently your net worth is zero. You have $4,000 in positive assets and $4,000 in negative liabilities, and they balance out to zero. If you use all your savings to pay off your debt you're left at zero. If you took the time to pay off debt with your income your net worth would be a positive $4,000. This is technically the right way to pay off debt.

But we live in the real world so I'm also going to give you a practical answer. Your interest rate is crazy, and to continue to pay that much in interest isn't great. I wouldn't feel comfortable with you having any less than $1,500 in savings, but you could take $2,500 from savings and put it toward your high interest credit card bill. The remaining $500 needed to cover the remainder will have to come from your income.

Hopefully it goes without saying, but if you are actively trying to pay off your debt, you shouldn't be adding new purchases to your credit card. It defeats the purpose.

Get at it, Rachel!

Courtesy of WIBC