Should I Pay Off My Credit Card Or Save?
According to a study conducted at the end of last year (2021), there is $804 billion dollars in credit card debt in America. This was an increase of over $17 million dollars of debt in just 3 months!
Having credit card debt or any type of debt can create a lot of stress and uncertainty on what is the right direction.
Should you pay down your credit card debt or save for the future?
Before we discuss this, let's first talk about what goes into a credit card.
Credit Card Components
There are a few key components that go into the makeup of your credit cards: the balance, minimum payment, the annual percentage rate (APR), an annual fee, cash back/rewards.
- Balance: your balance is the total amount of money that you owe the credit card company.
- Minimum Payment: the minimum payment is the lowest amount you can pay a month while keeping your account “current” rather than “late”. If your status goes to “late” you will be subject to additional fees.
- Annual Percentage Rate (APR): Your APR is based on your credit score. The better your credit score is the lower your APR, basically your APR is the “cost” of your credit card on the balances you carry. The average credit card APR is 18.26% for new card and 14.54% for existing cards.For example, if you opened a credit card with an 18.26% APR and held a $1,000 balance on it for a year, you would pay around $182.6 in interest.
- Annual Fee: Some credit cards come with annual fees. If you are carrying credit card debt, this is a possible area you can save some money by looking for a “free” credit card.
- Cash Back/Rewards: almost every credit card will give some form of a cash back or rewards program to incentivize you to use it. By knowing which cards give you more benefit you can truly maximize your rewards.
Now that you know what a credit card is made of, we can talk about the question of should you pay down your credit card or save for the future.
Paying High Interest
As mentioned before credit cards tend to have very high interest (although it is dependent on your individual credit score). When you carry a balance on your credit card and have a higher interest rate, it can really take a negative effect on your finances.
Let’s look at an example:
You have a credit card balance of $5,000 with an interest rate of 18%, your minimum payment is $100/month. In this example, it would take you 94 months (almost 8 years) to pay off the card. In addition to that, you will have paid $4,311 in interest to the credit card company, which is only $689 less than your original balance!
So, what can you do in this situation?
There are credit cards that will allow you to have an introduction period APR of 0% for 12-18 months. By utilizing this intro APR, you would be able to pay off the balance while not paying any interest. However, with balance transfers, there is usually a fee associated with the transfer. The range can be between 3-5% of the amount being transferred. To check out the latest credit card offers click here.
Another option you could look into is a personal loan. A personal loan is structured just like any other type of loan (mortgage, student loans, etc.). The loan will have a fixed payment amount and a term, some companies will even allow you to pay back the loan quicker (which will save you money in interest). To look at some options for personal loans click here.
Saving For The Future
The stock market has had an average return over the past 100 years of 10%. Now your individual portfolio may perform either better or worse depending on how the market does in a given year and how aggressive or conservative you are. Taking 10% as a benchmark will allow us to compare whether or not it's a good idea for you to save or pay down debt.
Continuing with the example of you paying a credit card 18% in interest and using the 10% growth in the market, it would be more beneficial to focus on the credit card because you would be still having a “loss” if you focused on investing.
10% (gains) – 18% (interest loss) = net 8% loss
Now, this example is not considering the amount of money that you would invest and the amount of money that you have on the credit card. It also does not take into consideration the compounding interest of both the gains/losses.
Finding The Balance
As with anything, it’s important to find the balance between paying off your debt and saving for the future. If you have high-interest debt and it is just growing, that should be a focus for you. If you are managing your debt and have it under control, then it might make sense to do both. Whether or not you should pay the debt off before you save for the future depends on your situation and you should discuss your situation with a professional.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax, legal, or investment advice and may not be relied on for purposes of avoiding any federal tax penalties. Individuals are encouraged to seek advice from their accountant, financial planner, and counsel. Neither the information presented, nor any opinion expressed constitutes a representation by WM Wealth Planning as a specific recommendation to the purchase or sale of any securities/investment. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by WM Wealth Planning for educational purposes*