Paying off your debts with your savings does sound rather bizarre. If you spend months or years saving up some spare cash why would you want to pay off your debts with it? The answer is quite simple and its all down to interest rates. Or specifically, the difference between the interest rate you are paying on your debt and the interest rate you are receiving on your savings.



The interest on your debt (e.g. credit card or loan) will nearly always be higher than the interest you will get on your savings. E.g. if you had $1000 worth of debt on a credit card at 18% interest this will cost you $180. If you had $1000 in saving you may only get a return of around 4% so you will only earn $40. Now, if you pay off your debt with your savings you will be $140 a year better off!





Its a simple formula that the fact that debts nearly always cost more than what your savings can earn. You are simply throwing money away and lining the lenders pockets by keeping your debts.



Now this may sound fine but most people have savings for a reason and that is often to have as an emergency fund in case the unexpected happens such an expensive car bill or your roof falling in. So how do we deal with emergencies without the cash in your account? Well fortunately emergencies dont happen very often and if you need to money then at you simply re-borrow it. The chances of needing large amounts of cash for regular emergencies are quite slim. You can even borrow the money and shift the debt to a credit card with a 0% balance transfer or low starter interest rate. There are many options.



Granted, if you re-borrow your $1000 to pay an emergency you are back in the situation you were in before you paid off the debt with your savings. However, if this emergency did not happen and you did not have to borrow the $1000, you have been $140 a year better off. So for every year you dont need to re-borrow, you are $140 a year better off. Save this $140 a year and you soon will have enough again for your emergency fund but without any debts!



The only time where paying off you debts with your savings does not work is if you have problems obtaining re-borrowing the cash but its usually possible if you have a credit card.