Saving with Debt

I never carry a balance on my credit card and would never recommend anyone else carry a balance either, not by virtue alone but simply because of the cost of credit card debt.  If you’re like me and you’re dealing with modest finances you’ve got to protect what you have especially since interest rates for savers are so low and fees are not.   

If Jane lost her job during this time she would have no or limited savings and would have to use credit for expenses until she found another job. 

So when my old bank increased the minimum chequing balance for waiving monthly plan fees I moved my chequing account to an online, no fee bank, in silent protest.  They thought I couldn’t be bothered to redirect my direct deposits and withdrawals, they thought wrong!  

While I generally recommend aggressively paying down credit card debt, I was recently forced to consider that my friend’s niece might be better to keep $1200 in savings rather than use it to pay down credit card debt, regardless of interest costs.  In this case her interest rate was 20%.  My friend’s niece, who we’ll call Jane, is a recent graduate with a temporary job, earning minimum wage and living with roommates.

If you’re one of those living paycheque to paycheque you’re particularly vulnerable to the use of expensive credit such as credit cards or payday loans.

My absolute favourite resource we offer is the Credit Canada debt calculator and we used it to help get a plan in place for Jane.  We looked at three options:

1. Pay the minimum balance only which would take 198 months to pay off and cost $1864.64 in interest. 
2. Pay $300 per month until the balance is paid in full which would take under 5 months and would cost $52.55 in interest.  If Jane lost her contract during this time she could revert to minimum payments from her savings account until she’s back to work.
3. Pay the balance in full and pay zero interest. It would take 4 months at $300 per month to rebuild the savings account but would cost $20 in plan fees once the balance dropped below the minimum and $7.40 in earned interest, a total loss of 27.40.   If Jane lost her job during this time she would have no or limited savings and would have to use credit for expenses until she found another job.  She would also have to use credit for any unexpected expenses that came up during this time. 

Jane decided that option 3 was best for her, as she would save $25.15 in interest, however there is a downside to this strategy. In the event that Jane had a financial emergency, she wouldn't have any savings to draw from. She could use her credit card to cover the emergency, but this would create a bad precedent when she is working on paying the balance down.  Option 2 may cost a little more in interest, but it would get Jane into the habit of setting aside money for a financial emergency.

If you’re one of those living paycheque to paycheque you’re particularly vulnerable to the use of expensive credit such as credit cards or payday loans as a last resort.  Having funds set aside for emergencies and periodic expenses so that credit is not needed can prevent debt from snowballing.

Some of the signs of financial difficulty are putting off important purchases such as eye glasses, making monthly minimum payments only or taking out payday loans.  If you find yourself in this situation or if you are contemplating using savings to pay off some or all of your debt it’s a good idea to seek out a credit counselling service such as ours and give us the opportunity to use our fancy debt calculator!