Should I Use My Savings to Pay Off a Loan?
- Author: Alicia Cole
- Posted: 2024-10-23
Welcome to a column where we talk about money advice! You can ask us anything about how to spend, save, or invest your money.
Today, we're answering questions from our readers.
Paying Off a Loan: Is It a Good Idea?
Let's use a reader from a Forbes article as an example. He is not sure if they should use their savings to completely pay off a $25,000 personal loan or just continue paying it little by little. This person works two jobs in Hawai’i and feels stuck.
They are thinking about paying off the entire loan to be debt-free but this would mean starting again from scratch with no savings.
They share some numbers with us:
- The loan's interest rate is 5.75%.
- The minimum monthly payment for the loan is $738.
- They make $1,500 every month from their two jobs.
- After covering necessary expenses, they have $200 left each month.
Originally, they took a $35,000 loan and in one year, they've managed to lower their debt to $24,800. They've been really careful with their money, cutting back on extra spending to pay more towards the loan. Good job, especially with a tight budget!
They're also thinking about using $20,000 from their life insurance fund, but this would leave both their savings and life insurance account empty, though debt-free.
Must Read: Understanding Financial Emergencies: A Comprehensive Guide
Is It Worth It?
Looking at their success in paying down 30% of the loan in a year, continuing to make payments could clear the loan in a few more years. This path requires careful budgeting, but avoiding new debts is essential.
Alternatively, using savings and life insurance to pay off the loan means they could refill their savings with what they would have paid on the loan, potentially getting back the $5,000 in around six months. However, this option leaves little safety net for emergencies.
There's an option to take money from the life insurance if it doesn't incur penalties, to significantly reduce the debt while preserving the $5,000 in savings for emergencies.
Deciding factors include: Do they have dependents who need the life insurance? And why did they need the loan originally? Avoiding future debt is crucial.
Sticking to the original payment plan might mean paying more interest overall, but their savings could also grow, offering a bit of financial growth and keeping the life insurance cushion.
About Investing and Savings
Another reader wonders if it's smart to have both employer-sponsored retirement plans like 401(k)/403(b) and personal investment accounts.
Employer retirement plans are great since they often include company matching, effectively free money. But, they usually offer limited investment choices with possibly higher fees, compared to what you might find if you invest on your own through an IRA or brokerage account.
While investing in workplace retirement accounts is wise for their tax benefits and employer match, diversifying with an IRA or other accounts might offer more control and potentially better returns because of lower fees.
Making the most of your money might mean contributing just enough to your work plan to get any company match and tax advantages, then putting extra into an IRA you control or even a separate investment account not tied to retirement.
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