As an avid reader of The Simple Dollar’s ‘Improvisational Financials For Non Learners’ book, I noticed that they mentioned that they were going to be paying off a debt using the “Savings account method”. From what I read they simply pay off debt into a savings account instead of paying off the debt directly. This they use as an emergency fund until the savings account is much larger than the debt, and they pay off the debt all at once.
This seems like a great method to me for those who are having trouble saving and paying off debts. It gives you the best of both worlds. An emergency fund to use in case life throws something at you that you weren’t expecting and a steady method of working towards paying off your debt. Most likely you will lose money doing it this way, though, but it will give you piece of mind and a way to make sure you don’t incur more debt.
Just as an example, imagine you are working to pay off a $10,000 debt at 8%, and you think you can put in about $500 a month if you work really hard at it. At that rate, if you put all the money into paying off debt, you’ll pay it off in about 22 months. During that time, you’ll have paid about $692 in interest. If you put the money into a 5.05% savings account, such as Emigrant Direct during that time, you’ll earn about $500 in interest. But remember, if you are putting your money into savings and not into paying off the debt, the interest you pay will be higher (the $692 takes into account your payments every month reducing the debt.) If you can somehow manage to pay nothing on the debt for two years, you’ll have paid an extra $1467 in interest. So it costs you almost another $1,000 to use the savings account method!
So it would seem that the savings account method is not for everyone. If you don’t have an emergency fund, I would make one and use this method to pay off your debt while you are earning interest. However, if you already have an emergency fund that covers a few months of living expenses and you want to pay off higher interest debt, I would seriously consider just paying it off month by month as you are able to.