helplient Case Study: Savings vs. Debt
When is adding more to savings not the best advice? When you are earning roughly 1% on savings beyond your emergency fund and paying 20+% on a credit card.
My client Sam was doing a lot of things right. He had a good job making good money and was living in an apartment that was well within his means. He also didn't have a car payment, and he had a huge savings account. However, he had several credit cards that he was juggling for points or other incentives, and because there were so many of them, he really wasn't able to mentally keep track of what he'd spent from his checking account and across all the cards and so would overspend and roll a balance.
This is the exact scenario banks hope for when they issue credit cards with incentives and other promotions. Add up everything you pay in interest, and you may be surprised to learn it exceeds the cost of the flight or cash back you received. While some people do game the system, the credit card company only needs you to get busy and drop the ball once or twice for them to win. Otherwise they wouldn't offer these types of promotions! I'm not 100% anti-credit card, but having worked for a credit card processor (and having helped the banks implement programs to make money from their clients), I can tell you they are very savvy at it, so you need to be very careful when playing chess with them.
The client and I worked together to determine what amount of his savings account was his emergency fund, settling on six months worth of his spending since he was single. He then decided to pay off the credit cards with a portion of the remaining savings.
The remainder of the savings he'd earmarked for the down payment on a house. He was planning to move to California to be with his girlfriend, work there for 5 years, and then move to a lower cost of living area and buy a house valued at roughly $500,000. He'd heard that 20% was required as a down payment and so believed he needed $100,000 in the bank to purchase his first home.
While it is correct that buyers usually get the best interest rate when they have 20% to put down, we talked about the fact that there are many first time home buyers programs available that require a much smaller down payment. While the market and the regulatory environment could change between now and 5 years from now, I explained that we had bought and sold multiple houses, and only now, on our 4th house, had we chosen to put 20% down. That made him feel more comfortable with paying off his credit cards, since he knew there would likely be options down the road even if he did not have $100,000 in savings.
To make tracking simpler, he decided to carry only his debit card and the one credit card with the best incentives, so he could better mentally track how much he was spending in a month. We also talked about the importance of tracking expenses with an application and not just in his head, either using Quicken (which he uses now, but only once ever few months) or You Need A Budget, which I use, to give visibility as the month is progressing how your money is flowing.
Are you interested in getting control over your money? Interested in getting on track to buy your first home? Contact me to learn more about my coaching programs so you can get support in your financial life.
*Client name and some details have been changed to protect privacy.
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