Imagine a situation where a couple, whose house was paid off, decided to downsize and — after paying for a new, smaller house — has about $50,000 left over.
Deborah’s husband, Pete, wants to pay off their $50,000 credit card debt, but Deborah wants to put the money in a high-interest savings account (HISA). Both are working, have benefits and have 401(k)s with employer matching.
However, because they put their extra money into paying down their first house, they don’t have other savings. Other than their credit card debt, they don’t have other high-interest debt, don’t have kids and don’t anticipate making any major purchases in the next few years.
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The pros and cons of each approach
Many financial planners would advise paying off the debt. “If you have credit card debt that is increasing and you’re paying high interest, you definitely want to pay that off first,” Stuart Boxenbaum, president of Statewide Financial Group, told CBS News.
Personal finance expert Dave Ramsey would agree — for the most part. He recommends what he calls the 7 Baby Steps, which starts by saving $1,000 in a ‘starter’ emergency fund and then paying off non-housing debt.
From there, he recommends building a more substantial emergency fund (saving three to six months of expenses) and then investing 15% of your income for retirement.
In the case of Deborah and Pete, the advantage of paying off their credit card debt could mean saving thousands of dollars in interest.
Consider that the average credit card interest rate in the U.S. is 24.33%, according to LendingTree. On a debt of $50,000, interest starts adding up fast if you’re only making minimum payments.
The downside? They’d temporarily reduce liquidity. If they put the money in an interest-bearing account, they’d have full access to that cash if they need it.
However, the rate on a high-interest savings account is currently around 4%, so even doing some simple math shows that the annual percentage yield on a HISA won’t outpace credit card interest.
Rod Griffin, senior director of public education and advocacy at Experian, told CNET that “paying off debt and saving money doesn’t have to be all or nothing,” and that consumers “can and should do both.”
That may mean building an emergency fund and paying down debt (or following Ramsey’s approach with a ‘starter’ emergency fund, paying off high-interest debt and then building a larger emergency fund).
A HISA can make that emergency fund work for you. “For example, instead of having your emergency fund sitting idle and earning next to nothing, a high-yield savings account can help you earn a real return on your money while still keeping it readily available for unexpected expenses,” Kristen Beckstead, vice-president and financial planner at First Horizon Advisors, told CBS News.
Read more: Want an extra $1,300,000 when you retire? Dave Ramsey says this 7-step plan ‘works every single time’ to kill debt, get rich in America — and that ‘anyone’ can do it
Couples need to work together on their finances
Deborah and Pete may decide to pay off the full $50,000 balance to stop the high-interest bleeding. Or they could reach a middle ground.
Since they don’t have an emergency fund, they may want to put a portion of that money aside — enough to cover three to six months of expenses — and then pay down as much of the debt as possible with the remaining money.
More importantly, they may want to examine their financial plan and how they’re managing their finances as a couple. It can help to do this with a financial planner, who can provide them with various options and be an impartial third-party to help them navigate what can sometimes be difficult conversations.
“Money is the number one issue married couples fight about, and it’s the second-leading cause of divorce, behind infidelity,” says finance expert Rachel Cruze in a blog for Ramsey Solutions.
After all, people come into a marriage with different money mindsets — the attitudes and beliefs we each hold about money and how that influences the way we manage our finances. But, once you’re married, you need to manage financial matters as a team.
To do this, Cruze recommends keeping a joint bank account, since “separating the money and splitting the bills is a bad idea that only leads to more money and relationship problems down the road.” She says couples should also discuss lifestyle choices together, recognize differences in personality and keep purchases out in the open.
Working together and communicating isn’t easy, especially when each partner has different money mindsets, but it can help couples like Deborah and Pete find a solution that works for both partners.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.