Saving account tips to reduce debts

Posted by admin on Mar 11, 2011

One of the most common problems experienced by individuals and couples who have managed to accumulate a certain amount of savings is that if you must use those savings to reduce or repay the debts. Certainly, anyone who has savings and at the same time, has some kind of debt is incurring a financial cost by using the saved resources to reduce or pay off those debts. The reason for this is that, with rare exceptions, the cost of borrowing (the interest paid) will always be greater than the benefit we generate savings (interest received).

For example, consider the case of an individual who has US $ 100,000 in a savings account "ABC Bank" for which the bank would pay 5% interest per year (equivalent to US $ 5,000 per year). This individual also has a car loan with the same bank amounting to US $ 100,000 to an annual interest rate of 15% (equivalent to US $ 15,000 per year).

From this point of view, anyone tempted to conclude that it makes no sense to have money saved while at the same time; it has some kind of debt. However, before rushing to a conclusion, we must consider how important it can be, to have a reserve fund.

Creation of a reserve fund

Indeed, anyone who has sought advice on how to manage their personal finances, whether in a book or by some direct consultation with an expert, probably has received the recommendation to establish a savings plan that allows you to accumulate a reserve fund equivalent to at least 3 to 6 months of fixed expenses.

The objective of this fund is to provide security for quick access to some amount of money for an unforeseen situation (job loss, illness, accident, natural disaster losses, among others).

What if, instead of keeping my reserve fund in a savings account (which pays very low interest rates), I try to make investments that are more profitable?
It is important to note that, with a very few exceptions, any investment that has the potential to generate higher profits involves a certain level of risk. In other words, there is a possibility that failures to achieve expected results or even lose all the resources invested.

We must always remember that the goal of the reserve fund is to ensure the provision of quick access to some resources to deal with unforeseen situations.

The clearing of debts

Some other factors to take into consideration -whether we should use our savings to pay debts- consist of the type of debt we have.

1. Credit card debt or debts with moneylenders: If you have this type of debt and have some money saved (including the reserve fund), I recommend that you use to reduce or repay them. In this case, it is preferable to eliminate the debt as quickly as possible and start a new plan to return to accumulate savings.

2. Vehicle Loans: If the monthly fee that generates this debt represents a burden to your monthly income, would not recommend using reserve fund to reduce or repay this debt. However, if you have savings above the recommended amount as a reserve fund, I recommend that you use the surplus to reduce or pay off debt. If for some reason, the monthly income has fallen after taking a loan to purchase the vehicle, the fee may represent a heavy burden, and then recommended to use the reserve fund to reduce debt.

3. Mortgage Loans and Housing: In addition to this, consider that in the long term, we buy homes with these loans and generate an additional benefit surplus and inflation protection. For these reasons, usually not recommended to use savings to reduce or pay off these debts (even if you have savings beyond the recommended as a reserve fund). In fact, in this situation, perhaps the ideal would be some kind of investment that more profitable. Obviously, this is the recommended in cases where payment of the loan fee does not present an unreasonable burden on the monthly income.

In conclusion, we can say that, prior to use savings to reduce debt, you must complete the financial situation very carefully. In most cases, I recommend that the creation of a savings plan that makes available a reserve fund (although this has an implicit financial cost). However, in cases where the debts have a very high cost or a burden too big month, recommended the same pay as soon as possible.

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