If You Have Credit Card Debt, You’re Losing Money By Saving
It seems counterintuitive, but if you have credit card debt, you’re actually losing money by saving instead of paying down your debt. It may feel like you’re moving forward, but you’re actually moving backward.?People tend to compartmentalize cash and credit card debt and this can get them in trouble. While having cash in a bank account can give you peace of mind, this is an illusion?if you have credit card debt.
The truth is, money in a savings account isn’t doing much for you. Even if it earns a bit of interest, that earned interest is easily dwarfed by the interest you’re being charged on credit card balances. Put simply, if the interest you’re earning on savings is less than the interest you’re charged on debt, you’re losing money.
The average interest rate on savings accounts currently ranges from 0.01% – 1.45%
Meanwhile, the interest (APR) charged on credit card balances could be anywhere from 14% – 22%.
What’s Really Happening
If you look at your credit card statement closely, you will notice a “disclosure box” that warns you how much interest you will pay if you continue to only make the minimum payment compared to how much you will pay if you raise the monthly payment enough to pay the balance off in 36 months (3 years).
It usually reads something like this:? “Making only the minimum payment will increase the amount of interest you pay and the time it takes to repay your balance.” The difference is quite shocking.?The credit card companies don’t disclose this information because they want to. They disclose it because the Credit Card Act of 2009 forced them to. You owe to yourself to check yours out.
An Illustration of the Illusion
Here’s an example of what saving $100 per month at 1% interest will yield compared to interest charged that you could avoid by allocating that extra $100 dollars to a credit card balance of $5,000 with 17% APR instead.
If you use the $100 per month to pay off debt, you’ll avoid paying $3,297 in interest charges over 3 years. If you invest the $100 instead, you’ll earn $35 after you pay taxes.
So, if you save $100 per month in a savings account for 3 years instead of throwing it at your debt, you will be left with all of $303 for your troubles. But if you allot that $100 to your credit card bill, you will save $3,192 in interest charges ($3,297 interest paid on the credit card less the $35 interest you would have earned in savings.) As you can see, the longer you drag out your payments, the more you pay in interest. You can customize your own personal configuration to check out how much you can save by?using this calculator.
Remember that the amount you savein interest charges on your debt is the same as earningthat interest on your savings. In other words, don?t save money to earn 1% interest if you?re paying 17% on debt.
Don’t Build Emergency Savings if you have Credit Card Debt
While the idea of not having “emergency savings” in the bank may seem?scary, remember, your money isn’t helping you in the bank. But it?s helping the bank quite a bit though. The bank is loaning out your money to make money for themselves. Meanwhile, interest is accumulating quickly on your credit card debt, pushing you further and further into debt. The banks are double dipping and this should piss you off.
Paying Down Credit Card Debt Is An Excellent Investment
Savings accounts are poor investment vehicles. They simply do not pay enough interest to keep up with inflation. In fact, you would actually be hard-pressed to find an investment vehicle that could deliver guaranteed returns which are more than the interest you are paying on your credit card debt. If you look at it this way, paying down your credit card debt means you are getting a return which beats the market. Pretty cool, right?
Having emergency savings is a popular idea. But think about it. The odds that you are going to have an emergency are much less than the 100% certainty of paying a ridiculous amount in interest over time the longer you drag out your credit card payments. Paying down your consumer debt first will relieve you of chronic money problems and allow you to save more in the future.??
Rethink Your Strategies
If you can use some of your money allocated for savings to attack your credit cards, you will end up with more money in the long run. If you look at the big picture, your savings balance is not the safety net it appears to be when you have a huge liability hanging over your head that has the potential to cause you sustained financial damage.
Ideally, we want no debt and savings. But it’s really important to make eliminating consumer debt the first priority. You can’t really save money if the amount you are putting in is less than the amount that’s bleeding out. A boat that takes in water at a faster rate than you can bail is eventually going to sink.
The word interest is …interesting. There are two definitions:
State of wanting to know or learn about something or someone.
?He looked around with interest?
Money paid regularly at a particular rate for the use of money lent, or for delaying the repayment of a debt. “He’s paying 17% interest on his loan.”
If you really think about it, these definitions are more connected that they seem. Why? Because the way we use our money is an expression of who we are.? It is true that what we appreciate, appreciates. Spending time with our kids, putting in the hours to grow a business or volunteering at our favorite charity amplifies all of those aspects of our lives.? And guess what? The interest we give to banks has similar power.
How Banks Use Your Interest
When you place your money in a bank account, it doesn?t just sit there. The bank uses your money by lending it out to others. They make money from lending out YOUR money. And you may not always like where they put it. Some banks invest in things like private prisons and fossil fuels, or engage in shady business practices that hurt customers or communities. ?By the way, the same goes for the interest you pay on your loans.
So… How Much Money are we Talking About?
How big is the impact of your financial interest on the world? In 2017:
Global companies borrowed more than?$3.74 trillion dollars?to expand their businesses. Where do banks get the money they lend out to companies? You guessed it: from your deposits.
U.S. household debt reached $13 trillion dollars. The banks make money from the interest you pay on your loans, mortgage and credit cards. The average U.S. household paid almost $1,000 of interest just on their credit card balances.
Use Your Money To Express Your Deepest Self
Think about where you put your interest. Money has power. It is a mirror of who you are. It is an instrument that can help you evolve your own view of the world.?When you align your financial life with what you stand for, you will feel truly prosperous.
Start Small for Big Impact
This doesn’t need to be a huge overhaul. You can take small steps toward lining up your existing money (cash, loans, credit cards and investments) with institutions that share your evolving worldview.
No matter how much money you have, you have power to express your deepest self by the way that your money moves in the world.?Take your first step.?Check out these resources:
There are two powerful forces that are as essential to finance as gravity is to the universe:
The idea of time is straightforward, but compound interest can be confusing to people who are new to the world of finance and money. Understanding compound interest can exponentially increase the amount of money you earn in the bank, and who doesn?t want that? Let me help you wrap your head around how it works so that you can reap the benefits of compound interest and time.
Two Quick Definitions
If you?re really new, here are a few terms to understand. If you know them, then you can skip to the next header.
The principle is how much money you initially throw in the bank. If I go deposit $5,000, then my principle is $5,000.
Interest is how much money you earn from your principle. Interest is always written as a percentage. That percentage is how much more money I get at the end of a certain amount of time from having my principle sit in the bank. For example, if I earn 10% interest per year on my $5,000, then I get another $500 at the end of the year.
So far, we?ve put $5,000 in the bank and earned $500 in interest, because the interest rate is 10% of the $5,000 we put in. Now we have $5,500 in the bank and all we did was drive to the bank a year ago. That sounds great, so what?s the big deal about compound interest?
Compound interest is interest that you earn on your interest. Let?s keep all the same numbers. You put $5,000 in the bank, earn 10% interest, and after a year you have $5,500 in the bank. If you save that money for one more year with a compound interest rate of 10%, you?ll get 10% on your initial $5,000 PLUS 10% on your $500 interest earnings. That?s another $500 from your principle and an extra $50 from your interest.
I can already see the comments saying ?That?s it? The 8th wonder of the world is worth 50 bucks?? After one year, yeah, it?s only $50. But after 40 years, you?ll have $226,296.28 without touching your money once.
That means if you?re 25 and you put $5,000 in the bank, you don’t put in a penny more, and that money grows at 10% compound interest, you?ll have $226,296.28 waiting for you in your retirement account at 65.
If you?re 20 and you wait until you?re 65, you?ll have $364,452.42. Compound interest?s real value comes with time.
Compound Interest?s Best Friend: Time
Here?s how we jumped from $5,000 to over $200,000. After one year at 10% interest, you get your $5,500. Another year goes by and you earn another $500 from your principle and $50 on that interest.
One more year goes by, and you not only earn $500 from the 10% on your principle, but you also earn $55 from the 10% of your principle interest and 10% of the $50 in interest you earned the year before. Every year, your interest compounds itself and grows year after year. There?s a great online calculator that does all of this for you. So now you?re probably wondering?
How does this work in real life?
A 10% interest rate is great for calculating easy numbers for an article I?ll spend 90 minutes writing, but a real bank will only give you a compound interest rate between 0.1-1.05% per year.?To get the high earnings over time, you have to add money to your account every month. When you do that, both your interest payments and your principle increase. Just adding 10% of your check to your account?every month can have a huge impact on your savings in the future.
Let?s say you get the low end of the stick and get a .1% compound interest rate. If you put $5,000 in the bank and put $300 in that account every month for 40 years, You?ll end up with $152,047.85 in the bank just in time for your retirement account to open. Start earlier and wait 45 years, and you?ll have $170,845.65. That?s almost $19,000 more than the other guy who started saving just five years later.
But you don’t have to settle for 0.1-1.05% in a savings or checking account. You can earn a lot more if you start investing. Investing carries more risk (the value could go up or down in any given year) but your returns could be a lot higher. On average, the S&P 500 has returned 7% since its inception in 1928. The S&P 500 is a broad market index that gives you a high level picture of how the stock market is doing.
The next time you think about buying that $70 hoodie, think about what $70 would be worth in 40 years. At 10% annual interest rate, it’s?$3,168.
In this article, I assumed that you have a retirement account that you?re putting money into and I made it sound like giving up 10% of your monthly check is easy. I know that neither of those things are true for everyone. What you should take away from this anyway is:
Small savings over time can make a big impact
Time is your friend
Young people have one advantage our parents and grandparents don?t have: time. If you start saving early, you will thank yourself when you reach retirement and have that extra cash waiting for you.
Open a separate savings account and checking account. These accounts are low risk since the interest is pretty much guaranteed. But the interest is low. Even the ones that advertise “high interest” are only high when compared to other savings and checking accounts. Open a separate account anyway. Getting 1% on checking will help your money counteract inflation and gives you a separate bucket of money that you can grow over time (instead of spending it).
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