Q: My wife and I are recently married. Between us we have about $20,000 in bills and $25,000 in savings. I'm concerned that if we take the savings and pay off the debt, it will leave us cash poor with no emergency funds. Also, I own a house that is about $10,000 upside down, but we'd like to buy a different house. If we use the savings to pay off the bills, there goes the down payment on the house. What's the best course of action?
A: Your question touches a central aspects of financial planning, and that is prioritization. People often find themselves with competing financial goals, so they need to go through the process of deciding which is most important.
Before discussing the goals raised in your question, it's important to address two missing pieces of information:
- Do you and/or your wife have steady jobs?
- Are you living within your means?
If you don't have steady jobs, then the strategy would be to hold onto as much cash as you can, paying just the minimum bill payments to avoid delinquency. Also, if you are racking up new bills at a faster rate than income is coming in, your first priority should be to cut your expenses.
On the other hand, if you have good jobs and are living within your means, you can turn your attention to the financial goals raised in your question. One thing that might help you prioritize those goals is a look at some interest rate differentials:
- Interest on savings accounts is down to an average of 0.09 percent.
- Current mortgage rates are below 4 percent.
- Credit card interest is running at about 13 percent.
What this adds up to is that you don't get paid much for savings, while credit card interest is very expensive. Current mortgage rates are a good deal, so if you have to have debt, it is much better to have it in the form of a mortgage than in credit card debt.
Given this environment, you might want to think about applying your savings to pay off your outstanding bills. This will still leave you with $5,000 for emergencies, and assuming you are steadily employed and living within your means, you can start rebuilding that savings. This approach will sharply cut your interest expenses, and should help your credit record. That record will enable you tap into credit in an emergency, and will help with your eventual goal of getting a new mortgage.
However, that new house may have to be put off for a year or two. This will let you rebuild both the equity in your current home and your savings for a down payment.
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