Wipe out savings to pay off debt?
March 8, 2011 2:15 PM

Should I wipe out most of my savings to pay off my credit card debt? It's kind of a long story.

I racked up quite a bit of credit card debt a few years ago, and then moved and was underemployed for a little while. In that time, I couldn't pay my bills, so the company closed my account and gave me five years to pay the amount off with a fixed monthly fee (somewhat substantial, but less than I would have had to pay otherwise).

Meanwhile, I was involved in a lawsuit that resulted in me having some money set aside in some mutual funds for future medical expenses.

Now I'm in a real job again, but my salary doesn't quite pay for all my bills and things, and I've been siphoning my future medical money to make ends meet. I'm wondering if it would be more practical to just pay off the remaining debt, which in theory would give me enough money to live on month-to-month, but would mean most of my lawsuit money disappearing. On the other hand, I know I don't make enough to cover all my bills, so I'll slowly be whittling away at that money anyway, but it's still a big chunk if there's an emergency (I do have good health insurance if that matters).

I kind of would like to just get this debt erased already, but am not sure wiping out most of my savings is wise. And splitting the difference and paying off a big portion of the debt doesn't do much good, since the payment is fixed and I'll still struggle to make ends meet every month till it's gone.

Advice, Mefites?
posted by anonymous to Work & Money (18 answers total) 2 users marked this as a favorite
Speak to your creditor and see if they will offer you a worthwhile rebate if you settle your debt immediately. If your debt has been resold there's a strong likelihood they'll say yes. Otherwise, interest rates are likely to increase in the near future so keep your cash. I am not an independent financial advisor.
posted by tigrefacile at 2:25 PM on March 8, 2011


how large is the debt that's left? if you're able to pay a large chunk of it off in one go, you might be able to negotiate with the company to either lower the interest rate or payment on what's left, or wipe out the debt altogether on the off chance they might just decide it's best to walk away with whatever they can get right now.
posted by lia at 2:26 PM on March 8, 2011


The way I think about debt, paying it off is like investing money with a guaranteed rate of return. If you have debt at 10% interest, and pay it off, it's as if you lucked into an investment guaranteed to pay at that rate.

That said, if you are left with no cash, you may wind up in a worse position due to unforseen events. Keeping some money to yourself is a way of preventing a larger debt down the road.

I'd recommend keeping enough cash for a few months expenses as insurance against job loss, your car needing repair, and illness, and using the rest to pay off the debt.
posted by zippy at 2:37 PM on March 8, 2011


This seems like something that you should be asking an accountant or financial planner.

You can't get good advice on this topic without providing (a lot) more information than you already have. How much debt do you have? How much are you getting from the lawsuit? How far above your means are you currently living? How stable is your job? Are you going to be able to eventually earn enough to make ends meet? Why don't you expect to actually incur any of those future medical expenses, and does the settlement allow you to spend that money freely?

Because it's a bad idea to share that stuff on the internet, you should be consulting a trained professional who is an expert on these matters, especially given the complexity and unusualness of your situation.
posted by schmod at 2:44 PM on March 8, 2011


I would not do it until your situation is a little more stable. For example, if you paid off the debt and then lost your job (and so, also your insurance), and then you did have one of those medical expenses that the money was set aside for -- what would you do then?
posted by Houstonian at 2:46 PM on March 8, 2011


Call the card companies, tell them you're going to cancel the cards if they don't give you a lower rate. Then you can decide.

But if it were me? Pay it off, right now. Carrying a debt like this is just silly.
posted by Cool Papa Bell at 2:57 PM on March 8, 2011


Interest rates on debts are always higher than interest rates on savings. There are no exceptions.

Your debt is costing you more than your savings are making you.

Repay your debt. Rebuild your savings.
posted by dougrayrankin at 3:03 PM on March 8, 2011


The big-picture answer is that you need to find a way to live within your means. Your current income and lifestyle are requiring you to run down your savings, which only works until the savings run out.

Personally I hate having debt and am willing to make big sacrifices (including using savings) to make it disappear. But as others have said, there isn't really enough information here to answer the question; there are a million specifics that could change everything.
posted by Forktine at 3:11 PM on March 8, 2011


Call the card company and ask them to settle. Often they will for a fraction of what you owe. You're already a charge-off anyway, right?
posted by elpea at 3:19 PM on March 8, 2011


dougrayrankin - government subsidies of interest rates provide an exception to your rule. Someone I know is paying 1.6% interest on a Stafford loan while earning 2.25% on an NCEU insured retirement account.

But in almost every other case your rule is correct.
posted by ChrisHartley at 3:21 PM on March 8, 2011


If you pay it all off now will it come out to less? I would call and ask- it's not unlikely that they'd negotiate something like that, since they'll see it as coming out ahead (a known chunk of money vs. an anticipated-not-guaranteed series of payment). It's possible you won't have to pay as much interest if you pay a big chunk of it off.

If paying off a chunk means you'll pay less, I'd set aside 3-6 month's worth of bare-bones expenses' (meaning, you'd be living off rice and beans) worth of emergency money and then use the rest to pay down as much of the debt as you can.

I wouldn't pay it all off and not leave myself an emergency fund, though. If your job is super secure and this debt is bugging the heck out of you, just leave a couple thousand for an emgergency fund. It'll mean you're skating on thin ice, but sometimes it's worth it to have a debt off your back.
posted by small_ruminant at 3:30 PM on March 8, 2011


Do you have access to credit? If so, you can pay off the debt now, and rely on credit in the future if you wind up needing emergency funds. Doing this makes having future debt a possibility rather than a certainty, and saves you all the monthly debt payments between now and whenever you would finally decide to pay it off. This would be the obvious choice unless the interest rates on your current debt are significantly lower than those of any future debt and the risk of future debt is high, and/or if your savings are earning more monthly interest than your monthly debt payments.
posted by PercussivePaul at 3:56 PM on March 8, 2011


anonymous: I'll still struggle to make ends meet every month till it's gone.

You need to either drastically cut your living costs so that your pay covers your expenses, including this debt, or pay it off. If you pay it off, however, you still need to cut costs and make a commitment to rebuilding savings with a solid plan.
posted by DarlingBri at 4:10 PM on March 8, 2011


The interest rate that a bank charges for debt (call this d) is almost always greater than the interest rate an investment fund will return on investment (call this m). If that's the case for you, read on.

Right now, you have a chunk of money $M sitting in an investment account earning m% per year.

You also have a chunk of debt $D which is costing you d% per year to maintain.

Your expected net earnings from these arrangements are $(M*m - D*d) / 100 per year.


If you were to use investment account money to pay off the debt, your investment account balance would be reduced to $(M - D) so you'd then be earning $(M - D) * m / 100 per year from that investment.

Another way to write that it $(M*m - D*m) / 100 per year. And since m is less than d, D*m is less than D*d, and the resultant net earnings are higher. Paying off your whole debt if you are able to do so will increase the amount of money you have available to cover other expenses.

If you've been making regular payments to pay down the debt, keep on doing that - but pay them into your investment fund instead. Just reduce the amount of that payment to the point where your current account isn't going backwards, so that you no longer need to draw down your investment fund, and you'll have the satisfaction and security of watching it grow over time.

If you have quick access to credit, you don't actually need to be maintaining an emergency nest egg; you can go into debt again to cover whatever emergency, then pay it down afterwards. Also, having paid off your current debt will do good things for your credit rating, which should make any required emergency debt somewhat cheaper to get.
posted by flabdablet at 5:09 PM on March 8, 2011


Another way to look at this is to think about the following easy-money scheme: get a credit card cash advance for $2000 and dump it in a mutual fund. Does that work? Clearly no, because the mutual fund only pays 7% and the credit card debt costs 15%.

That's the scheme you're running right now. Cancel it all out and you'll be better off.
posted by flabdablet at 5:17 PM on March 8, 2011


The National Foundation for Credit Counseling can help you locate a local credit counselor who may be able to give you targeted advice if you're in the US.

Personally, I'd do as others have suggested and set aside a portion for an emergency fund. Then I'd think about calling for a settlement. Good luck!
posted by dragonplayer at 5:32 PM on March 8, 2011


Good advice so far. Financially, it's a no-brainer to contact the debt holders, offer them settlements (try $.25 on the dollar and work your way up from there). Be clear of the hounding and the interest expense. You're better off, any way you slice it.

Now, the sorta bad news. If you do not budget carefully, you'll be back where you started. Not because of this maneuver, but because of a budget that isn't making ends meet. Presumably without the CC payments, it should be easier to do this, but it is imperative that you end up with a budget that provides for a strong amount of savings so that as quickly as possible, you have a war chest against future medical expenses.
posted by randomkeystrike at 7:45 PM on March 8, 2011


Several years ago, my eldest daughter ended up with a large debt because on an uninsured care accident. The debt was sold and she was paying it off, but she continually got offers to pay a reduced amount and wipe the debt out. She ended up saving quite a bit by paying it out when it got to a manageable point.

I would contact the credit company and ask if they would consider a reduced payment to wipe the debt. Let them come to you with an offer first but, no matter what the offer is, make a counter-offer. You might be surprised at how glad they will be to get x guaranteed dollars today as opposed to y maybe dollars spread over the next few years.

But you also need to deal with the core issue - you are spending more than you earn and there are two outcomes to this. If you keep paying off the debt, you will be left with no savings and still be in debt. If you pay of the debt, you have a chance to start afresh and set yourself a budget that allows you to at least not get any further in debt but, preferably, to start building up your savings again.

Generally, it is always better to get rid of debt because, as others have indicated, financial companies make money by borrowing money (your savings) at a lower interest rate then they sell it at. If you have both debt and savings, you end up getting screwed by the finance company with interest and by the bank who pays less interest than CPI.

Also, getting rid of debt does wonders for your mental health.
posted by dg at 9:48 PM on March 8, 2011


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