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Home > Why save when you’re Broke

Why save when you’re Broke

October 9th, 2006 at 03:33 pm

Why do people have a savings account when you’re in big time debt? When I used to work at a bank in Atlanta, I used to see thousands of people that had a savings account (earning 1.5% interest) and a maxed out credit card with an interest rate of 15% or more. This makes no sense at all. When you have an interest rate that is higher than the savings rate, you need to lower down your credit card balances before you save. Some people think that having an emergency fund is worth having even though you are in debt. I don’t really think that is true.

Example: You have $2000 of credit card debt (14% interest
You have $2000 in a savings account (4% interest)

Credit card monthly payment is $40.00
Total interest paid monthly ~$22.00
Savings account interest yearly payment is $80.00.
Monthly interest ~$6.00
Total loss of $16.00 per month or $192.00 per year.

Now just look at the figures. As you can see that is a difference of 10%. If that doesn’t turn you away maybe this will. Your income on that 4% is taxed, while the credit card debt is not tax deductible. This kind of situation you are being penalized to save. Pay off your balances then save.

After you pay off your credit cards then you can start pumping money in your emergency fund. If a situation does end up coming up and you don’t have any money in savings then use your credit cards to save the day again. Yes, you will be in the same situation as before, but you will still be saving a lot more money by paying credit cards off first.

If you are currently in this position don’t feel bad. I’ve been looking around many financial blogs and there are tons of people doing it. *including some authors that run the blogs?!?*

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20 Responses to “Why save when you’re Broke”

  1. pjmama Says:
    1160411169

    I think that's a little unfair. I'm a good few thousand in debt of student loans, and having a savings account helps me SAVE money because I dont spend it while it's in the account, and it gives me a goal to work towards. Even if I cant use it as an emergency account [which I cant], a lot of people do. You have to think about what would happen if you lost your job. I promise you that you wouldn't use the money to pay off your CC debt... it aint goin anywhere. You'd use your emergency funds to pay bills and buy groceries. There's more than one way of doing things, ya know :/

  2. yummy64 Says:
    1160412705

    I have to say the same thing, that the other commenter said. There is no one right way to save. YOu are solid on your math and the best mathematical way to save and be ahead. But you are a math geek. Not everyone gets all excited by the "perfect" mathematical way to do things.

    Personal Finance is about behaviour. The method that works best for a person is the method that works best based on how they think and act. It might not be technically the best way to do something but it will work whereas the "perfect" way might not work for that person.

  3. miclason Says:
    1160414248

    hmmmm....the flaw I see in it is this one: if I lost my job tomorrow I would probably use my cc for living expenses (my emergency fund wouldn't be able to cover living expenses for more than one month right now!)....and use the emergency fund money to make minimum payments on the cc until I found another job/an alternate source of income...at least in my country, the average time people remain unemployed after losing their job is 6 months...but, if you have nothing saved up, where would you get the money to pay for the cc??

  4. pjmama Says:
    1160415859

    By the way, I'm pretty good at math as well, and the interest rate on my student loan is well above 7% buddy, try 15. I pay the interest as I go because I'm still in school and cant afford to pay more. And just to clarify, I believe you should still pay minimum on your CC, miclason, I was merely insinuating that it is a smart choice to have at least a small emergency stash in case of something along those lines... though I guess some do use thier CC as emergency funds as well Smile And I dont believe all mathematics should be left out in the finance equation [obviously], but you have to consider the behaivoral aspects of it as well. Not all of us have the same spending habits... and some of us are working incredibly hard to improve them! I dont think it's fair for some people's efforts to be insulted because one person's "perfect system" works for them. So sorry we dont all have the willpower! sheesh...

  5. PRICEPLUS Says:
    1160416322

    I used to just pay bills and found that I was not happy with nothing for emergencies. Savings is a habit that must be developed so you don't run up new bills whiel paying off the old!Smile

  6. LuxLiving Says:
    1160418699

    I'm with priceplus - sometime it ISN"T all about the numbers. I saved while we were paying off credit cards. I look at like two tumblers sitting side by side. One labelled CC and another labelled Savings/Emergency Fund (YES, they were one and the same at the time). As the cc is being drained the savings is filling up. I was not happy just putting all my money towards debt. I needed to see my cash reserves building.

    Did it pass the geekmaster number test? According to you, no. However, it did allow that when something else errupted that I had not yet discovered I needed in my spending plans I could cover it with cash. ie; the car needing a new whatsit at 350.00. If I'd of had zero savings then it would have also had to go on the CC. This way I might zero out my little bit of savings, but by cracky I didn't put anything else on the dreaded CC. This scenario did happen to us as we began the turn around from no savings to having a years worth in the EF.

    I NEEDED to have the cash reserve. Emotionally and financially.

    I vote for saving SOME PORTION of your current income while paying as much as possible towards those CCs. Let's see, how'd I do it? If I recall when we had 200.00 to use, it went something like 50.00 to savings and 150.00 to CC. Agressive credit paydown while still allowing a bit to begin building up. I don't know how it would work for you but 4 years later we have a years salary PRETAX in savings and paid off apprx. 10,000 in CC debt and about 6-7 thou in car loans and continued to eat and have utilities, etc. All on a low 5 figure income.

    If people can't cut it emotionally on the desires - then they most likely WON'T do the financial necessities or even see the reason for it. Give people a REASON (emotion) then they will find a way to make the financial happen.

    YMMV.

  7. Taylor Strait Says:
    1160420155

    Credit is the SAME as a cash reserve, especially since most credit lendors allow you to write checks on a credit card account. But maintaining a balance on a charge account means that you are PAYING ~22%APR to keep cash in your savings account. Just pay off the card and use your credit limit as an emergency cash reserve.

  8. Amber Says:
    1160420491

    You are right, but I am one of those people who like the peace of mind. Knowing that I have funds set aside so that when an emegency arise I can use that verus the high interest CC, being that I am working on paying them off and trying my best not to add to them

  9. Broken Arrow Says:
    1160421615

    Hehehe. Quite an explosive topic, this one is. Get it? Explos... nevermind.

    Emergency Funds are a huge deal. That said, when I started out, I hedged my bet towards paying off my credit card first. Actually, before that, I saved a few hundred dollars for myself before I really got cracking on it. A few hundred makes sense since I had to have some way to cover myself while I was knocking the CCs.

    After that was done, I used it as my Emergency Fund while I was knocking down my car loan, and now my student loans.

    Of course, I also never in my life thought I would actually end up getting divorced... and lawyers are very, very expensive. But very necessary because I did not want to get screwwed, which would at the very least screw me out of even more money in the long run.

    Of course, because lawyers are very expensive, and because my divorce is not actually official, I've decided that it would be in my best interest to build up a normal emergency fund rather than to beat down my student loans (which is fairly low to begin with, at ~5%). Which is where I am at this point because I currently have no credit card debt....

    I guess my point to all this is that my real life needs and situations dictates how I really plan and strategize my personal finances. From a purely mathematical standpoint, it makes sense to pay down the credit card first. In fact, you'll get no argument from me. However, that's also under the assumption that you won't run into any realistic financial pitfalls that won't put you back into deep credit card debt. In the end, which way we go (and how far, because we can technically do a little bit of both) depends on where we are in life.

  10. flinnie Says:
    1160427901

    Yes this is a very Hot topic.
    I do all I can to pay my credit bills off each month but ,from december to march I play catch up. I don't have any kids but ,I do try to buy gifts for my
    sisters kids. Thouse gift are what put me in hot water.
    No matter what going on in my life financial I still try to have a saveing account to fall back on.

  11. pjmama Says:
    1160438994

    Once again to clarify, I'm not in debt because of excessive spending. My loans are my ONLY debt. And I wish what the government gave me in loans could cover my tuition, but sadly I had to resort to private education loans [sallie mae in case you were wondering] with only my credit to work on- my parents wouldn't cosign. I get no outside support, and I'm not in a financial situation where I can pay my tuition off from month to month. Instead I'm trying my best to keep up with a demanding job and my studies. Thanks for judging, buddy, they obviously dont teach compassion at your university. Not all of us can afford to buy a home at the age of 23, and most of us didn't hop on the financial responsibility train at the age of 13 either. I guess when you were following the stock markets I was too busy being a teenager...

  12. pjmama Says:
    1160486769

    "If you are in a huge amount of debt, and still saving money, and buying more stuff you don%u2019t need to increase your debt because of your "bad" spending habits I don%u2019t feel bad for you."
    This is where you were judging. I do nothing of the sort. And I dont disagree with you that kids should start saving earlier. Acutally, I wholeheartedly agree with you. I do not,however, agree with judging and/or insulting those who didn't get that kind of financial education at such a young age. And I also agree that my interest rate needs a little evaluation... I hope my salary as a psychiatrist when I get out of college and med school will pay off the debt I rack up now... I understand that college is an investment. And honestly, my current university was the cheapest I could go to in the city. And I'm not putting down your way of doing things. If it works for you then I support it entirely. I support anybody's way of handling thier finances if it works for them, I was merely pointing out that it does not work the same way for everyone, and harshly criticizing the methods in which people save while they try thier damndest is a little unfair. I dont think it's right that I should feel offended while I'm doing all in my power to save my money and not be heavily in debt when I get out of college, and I think the same goes for anyone else taking action to change thier situations.

  13. baselle Says:
    1160540912

    If you are currently in this position don’t feel bad. I’ve been looking around many financial blogs and there are tons of people doing it. *including some authors that run the blogs?!?*
    What does that mean?

  14. lily Says:
    1160921213

    Life is not a perfect mathematical equation. I think it is great that you started to save while the rest of us were out buying candy bars. But don't be smug about it. Life takes twists and turns and will bite you in the butt when your least expecting it. We're all works in progress and learning diffeent things at different times in our lives.

    I've known people who have done everything perfect and by the book and then when they reach middle age and go crazy(wine, women and song)because they haven't had any real life experiences. Their bored! So be careful being so smug

  15. Ali S. Says:
    1160928489

    I can totally understand the other people's argument here. When I was in college and getting myself in debt, I always had a small savings account because it made me comfortable, but then when I took a finance course my graduating year my whole mind was turned around. When we went over the chapter "time value of money" I was pretty much shocked. When I applied the things I learned in my class to my life, I did notice that I was saving a lot more money and I had way more piece of mind. Having cc debt and having a savings account really doesn’t make a ton of sense.

  16. LuxLiving Says:
    1161048413

    Have you factored in that many of us who were saving and paying down debt also had CC's with zero percent interest?

  17. JRBeaudry Says:
    1161048627

    "When you have an interest rate that is higher than the savings rate, you need to lower down your credit card balances before you save." Zero percent doesnt count. I would say anything under 7% for CC is too low, so you could still save or 9% and under for student loans.

  18. elgin526 Says:
    1161371988

    I think having a large amount in savings while having CC debt is unwise, but I do think a small emergency fund is a good idea. It can bridge a cash flow gap without haveing to charge something on your high interest credit cards. Dave Ramsey recomends $1,000, but many have closer to $2,000, depending on their situation. More than that, and you are paying too much interest for the sake of feeling more secure, in my opinion.

  19. tinapbeana Says:
    1161434040

    just my 18 cents here: my CC at 9% (about to go up to adjustable whateverness b/c the company got bought) doesn't have a large enough limit for me to use as a 2 month EF (even if it were paid in full today). therefore, in the interest of security, it would be foolish in my case to focus money on paying down that debt rather than creating and building an EF.

    all CCs, EFs, unemployment regulations, and monthly budgets are not created equal, and the only thing that makes mathematical sense is a plan that will allow you to survive and not default on your obligations should you lose your job for a period. for some folks, that's a fully funded EF. for others, it's a cleared CC balance.

  20. jb Says:
    1192877069

    What emergency is gonna wait for you to save when it comes.
    You do the best you can. If lucky enough to have an emergency fund ... good! If got CC balance available good also. Most people make financial mistakes before they realize they are in a credit trap. To pay off the credit debt assumes that you can pay them all off and then start on an emercency fund, mean while the CC can act as your EF.
    Not good to rely on CC balance. Credt card companies can change the balance available anytime. You need to work both at the same time.

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