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Don’t Save, Pay Off Debt!

Posted By Jim On 09/30/2005 @ 4:24 pm In Debt | 9 Comments

There are many debt reduction strategies out there but the idea is that you should be using your extra money to pay off the debt. I know there are people out there who are making the mistake of opening an FNBO Direct [3] account, putting in extra money, and not paying off more than the minimum payment on a credit card bill. They want to believe they’re getting that 4% interest and the fact that their credit card is only increasing isn’t something that they consider. So let’s do something very simple, let’s figure out where your next dollar should go: savings or bills?

First step is the list all of your debt, its associated rate, and order them in descending order by rate (these are imaginary):


Best Buy Credit Card 20.4%
MBNA Credit Card 19.4%
2nd Mortgage 7.59%
Mortgage 5.25%
Car Loans 4.0%
Student Loans 2.5%
Discover Card 0.00%

Now list all of your accounts (savings, checking, etc):


Emigrant Direct Savings 4.0%
6-mo CD 3.5%
Bank of America Savings 0.55%
Bank of America Checking 0.1%

Now order the whole table together, coloring the assets in green and the debts in red.


Best Buy Credit Card 20.4%
MBNA Credit Card 19.4%
2nd Mortgage 7.59%
Mortgage 5.25%
Car Loans 4.0%
Emigrant Direct Savings 4.0%
6-mo CD 3.5%
Student Loans 2.5%
Bank of America Savings 0.55%
Bank of America Checking 0.1%
Discover Card 0.00%

If you have any red accounts above a green account and that green account isn’t your emergency savings or otherwise earmarked for something important, you should take all the money from the green account and pay off the highest red account on your list. You should also do this from the bottom up. So in the case above, I’d liquidate the Bank of America Savings account and put it entirely towards the Best Buy Credit Card. (I assume checking is merely for day to day needs and doesn’t hold a sizeable amount)

Why this strategy? Because the debt is growing at a faster rate than the asset, so it would make more sense to put that asset towards slowing down the growth of your debt. Putting money in a savings account while keeping a larger interest debt account is like taking one-step forward and five steps back.

If you want to take it to the next level, you should adjust the rates to reflect what they are after tax benefits (or disadvantages). For example, the mortgage interest rates are actually a little lower because you can deduct them from your income and receive a rebate of some kind. However, that also lowers all your interest-bearing accounts as well because you need to report those at earnings and they will be taxed.

This all seems like common sense but sometimes people just don’t list every account they have and don’t realize they’re saving money at 4% but paying a debt at 20%.


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