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Paying down debt vs. preserving
savings
Dear Money Matters,
I have two credit cards. One is a platinum card at 11.4 percent
fixed with a balance of $4,300; the other card is at 16.89 percent
fixed with a balance of $2,197. I have a money market earning very
little, with a balance of about $7,800. Is it smarter to just pay
off the credit cards or at least the one for $2,197? I worry about
not having liquid assets in case of an emergency!
Jeannine
Dear Jeannine,
Your instincts are on the mark. It would be an excellent idea to
use at least part of your available cash to pay down your credit
cards. The primary reason is you're losing far more to interest
charges than you're earning with your money in a money market account,
which pays you in interest only a fraction of what you're shelling
out for the credit cards.
The real question is the best way to approach your
credit card payoff. You could take out both balances with the cash
you have on hand, but as you point out, that leaves you only about
$1,300 for emergencies. (Experts suggest setting aside as much as
three months' living expenses for an emergency fund.) At the very
least, I recommend paying off the $2,197 balance on the higher-rate
credit card. With that, you're effectively earning nearly 17 percent
by eliminating that debt -- much more than what you're earning in
the money market.
Now, to the remaining $4,300 on the 11.4 percent card.
Rather than taking the remaining money in the money market and zapping
the entire balance, consider earmarking a certain amount each month
and paying down the card as quickly and comfortably as possible.
To illustrate this, I used Bankrate.com's "What
will it take to pay off my credit card calculator."
I plugged in $300 a month -- at that rate, your entire balance is
eliminated in only 16 months. If you can up the amount to $500,
it only takes 10 months. This strategy lets you pay off the card
expediently without the necessity of committing a huge sum all at
once.
Finally, you should look at narrowing the gap between
the income you're earning in the money market account and the amount
you're paying. To narrow that gap, go to Bankrate's money
market search engine to find the best possible rate of income,
then to the credit
card search engine to shop for a better credit card rate. Even
if your credit is average, you should be able to find a card that
beats 16.89 percent. Transfer some or all of the debt to the new
card, but be careful of transfer
traps.
-- Posted: June 28, 2002
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