Pay Debt or Save for Emergencies?

When considering your finances and trying to piece together your financial picture, you will be in the position to consider whether or not it would be more beneficial to pay down debt or save for a rainy day. 

Which should it be?

If possible you should do both. If not possible to do both and you can only do one how do you determine which is the most beneficial?  

Let's look at the following scenario:

• you owe $3000 on a credit card and
• you have $3000 sitting in a savings account / investment product  

What are some of the factors to consider?

• What is the interest rate you're paying on the debt? 
• Money is a tool that should be used to grow not deplete your resources.   
• What is the cost of the credit? A credit card with a 19% interest rate would cost approx. $48.00 this month in interest on a $3000 balance. Next month, it could cost more if you were not able to pay the debt in full. The following month may have interest charges on the prior months interest charges.
• When you are paying interest that money is leaving you forever.  Interest is the cost of having debt.
• How much interest will you earn on the savings?

We all know we should save for a rainy day or for an emergency!

Let's consider the saving factors:

• If you had $3000 in an relatively accessible emergency fund, like a bank account, you may earn 1% interest this month which would be approx. $2.50
• Let's say you have that same $3000 in an investment fund which performed great last month, it earned about 10%.  You may have earned approx. $25.00 this month. 

What have we learned so far in this scenario:

The interest rate being charged which is also known as the cost of credit is higher than the interest rate we will earn whether we have a savings account or an investment product. We will earn a higher interest rate if we put our funds into an investment product rather than leaving the money in a traditional bank account.

What will you earn if you use your savings of $3000 and apply it to your credit card...you would actually be KEEPING IN YOUR POCKET $48.00 (which is the interest that you would have paid) You no longer have any debt because you used your savings to clear the debt.

If your debts interest rates are higher than the interest rates you are earning on your savings or investments you may be better off in the long run to use those funds to pay down your debt.