Monday, January 12, 2009

Extra Money? Invest In Your Debt

The Carnival of Personal Finance featured this post.

At the end of the month, when you have a little bit of money left over, what is the best thing to do with that money? Many people would say put this money away, or invest it in the stock market. This is a bad idea! The best thing to do with your money is to pay off outstanding debts

Staying in debt is the worst financial move you can possibly make. Your debt holders will always charge you a high interest rate, sucking money from your wallet. Many people are tricked into making the foolish decision of putting their extra money into some kind of savings account. People often stick with paying the minimum monthly amount towards their debts, and stash away extra money. However, the reality is that, this causes great financial distress. On average, you will always end up losing money by putting extra money in savings rather than paying off debts.

Here are some examples. Stocks are expected to have an average rate of return between 5-7%. A savings account is expected to earn interest at a rate of 2%. While a CD, depending on how long you put your money in for, is in between 2-3%. On the other hand, the average fixed interest rate for a standard fixed credit card is 13%. Loans for a new car are 7%.

Let’s say you have $100 left over at the end of the month. If you put this money into the best savings vehicle, stocks, after one year you will earn about $7. However, if you put this towards your credit card debt, this is $100 less dollars you will be charged interest on. That is $13 (13% of $100) less in interest payments you make. You can either earn $7, then pay $13 dollars in interest - meaning you will lose $6 overall. Or you can earn $13 by saving yourself interest payments. Which sounds better to you?

If you are putting your extra cash into a savings account instead of using it to pay off your credit card debt for example, you are losing money.  Not to mention your credit history is going down the drain (we will talk more about this in a later post).  Right now, thanks to the Federal Reserve, interest rates have plummeted, so banks are not even offering a decent rate for your money.  

That's not to say saving is a bad idea. Everyone needs to have money put away in case of an emergency. Just keep in mind that it is guaranteed you will save more money if you pay off your debts sooner rather than later.

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