Should you save or pay off debt?
This is a tough question for people with debt. But if you have savings, I encourage you to use it to pay off your high-rate debt.
In most cases, the best investment you can possibly make is to pay off your credit card debts and car loans. This is because the interest rates on such debt are higher than the rates you can expect to receive from almost any investment.
Paying off a loan with a 14% interest rate, for instance, is in effect paying yourself 14% interest, guaranteed and tax-free.
That’s a deal even Wall Street big shots would be thrilled to get.
A lot of people worry that by paying off their debt, they’re wasting their savings. But when it comes to high-rate debt, nothing could be further from the truth.
To better understand this, consider the following situation. You have a $1,000 loan for which you pay an annual interest rate of 14%. You also have $1,000 in the bank—earning interest at a rate of 3%.
If you keep the $1,000 in the bank for a year, you’ll earn $30 in interest on it while paying $140 in interest on the loan, ending up with a $110 loss. With me so far?
But if you take that money out of the savings account and pay off the loan immediately, you’ll earn no interest but you will also pay no interest. Clearly, it’s better to break even than to pay $110 in interest.