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Financial decisions can often become complex balancing acts in the journey of a dual-career couple. Among the most common conundrums faced is the decision between paying off debt and saving money. Both strategies are crucial for financial health, but prioritizing one over the other can significantly impact one's future financial stability and personal stress levels.
In this post, we will explore the factors that should influence your decision and offer a strategic approach tailored for couples who manage their finances as a team starting with three specific scenarios extracted from folks seeking help on Reddit.
Scenario 1: Should I Pay Off Debt or Save?
To provide a solution to the scenario presented above, I need to make an assumption that the credit card interest he is paying is greater than the interest he's earning in savings. This is a safe assumption, because as of August of 2024, the average credit card interest rate is 24.29%.
The solution is simple, use all of your savings to eliminate the highest interest rate credit card debt because he's paying far more in interest than what he's earning in interest.
Scenario 2: Should I Pay Off Debt or Save?
The simple solution
Use savings to eliminate the credit card debt, boosting his credit score.
The complex solution
The borrower suggested transferring the debt to a balance transfer credit card, which commonly offers a 0% interest rate for six months.
For this to work, the borrower should keep the full credit card balance amount in a separate high-yield savings account, which, as of August 2024, is earning, on average, 5%. Over six months, that account would earn $325 in interest.
When the payment is due the full credit card balance should be paid to avoid any interest or fees.
Scenario 3: Should I Pay Off Debt or Save?
According to a Douglas Elliman market report, the latest average cost of a condo in New York City is $690,000. Assuming this borrower will purchase an average-priced condo, he would need a $138,000 down payment, leading to a $552,000 loan and a $3,600 monthly payment at current 30-year mortgage interest rates.
The problem is that this monthly payment is 3x the recommended maximum income percentage to spend on housing, which is around a third of take-home pay. He earns $3,219.85 monthly, giving him $1,062 monthly to work with.
I don’t see a short-term solution based on his goals, which highlight the affordable housing crisis in New York City.
As it pertains to using his savings to eliminate his debt, he needs to decide whether to continue making car payments or consider selling his car and using public transportation to free up money to apply toward a mortgage payment.
The student loan interest rate is low and could include student loan forgiveness opportunities. I recommend speaking to a consultant such as someone with Student Loan Planner.
Clearly, he should eliminate 100% of his credit card debt before any fees or interest kicks in.
He does have the opportunity to earn higher interest on his savings accounts using Raisin to find the highest APY. I have used Raisin and the current APY on our savings account is 5.3% APY.
Understanding the Basics: Debt vs. Savings
Before we make any decisions, let's define what we mean by 'debt' and 'savings'.
Debt
Debt generally refers to borrowed money you must pay back, often with interest. This can include credit cards, student loans, car loans, and mortgages. Generally speaking, high-interest-rate debt is bad.
Not all debt is bad. Good debt can help your future self. A common example of good debt is a low-interest rate, affordable mortgage.
Savings
Savings, on the other hand, are funds that you set aside for future use and are not immediately available for spending. These funds might be earmarked for emergencies, retirement, or specific financial goals like buying a home or funding a vacation.
Not all saving is good. Tightwads find pain in spending, and their unwillingness to spend can create friction and strain in a marriage.
The Psychological Impact of Debt
Debt can be more than just a financial burden; it can also weigh heavily on your mental health. Studies have shown that high levels of debt are associated with increased stress, anxiety, and depression.
For many, the psychological benefit of reducing debt is significant; it can mean better sleep, less anxiety, and a clearer path to financial freedom.
The Financial Perspective: Interest Rates Matter
From a purely financial standpoint, the decision often boils down to the interest rates involved. A simple rule of thumb is to compare the interest rate on your debt with the potential return on your savings or investments. If the interest you’re paying on your debt is higher than what you could earn on your savings, it generally makes sense to pay off debt first.
For example, if you have credit card debt with an interest rate of 18% and a savings account that earns 1.5%, it’s financially wiser to prioritize paying off that high-interest debt.
Conversely, if you have a low-interest car loan at 3% and have the opportunity to invest in a retirement account that historically earns 7% annually, it might be more prudent to invest while making regular payments on the loan.
Related: Should I Pay Off My Mortgage or Invest (Scheduled)
Emergency Savings: A Non-Negotiable
Despite the mathematics of interest rates, one crucial element of financial planning is creating and maintaining an emergency fund. This fund should be equal to 3-6 months' worth of living expenses and considered a buffer against unexpected financial hardships like medical emergencies or sudden job loss.
Without this safety net, you're always one unexpected bill away from potential financial disaster.
Building this fund should be a priority for couples, even if it means just making minimum payments on low-interest debt for a while. Once the emergency fund is adequately funded, you can focus on paying down higher-interest debt more aggressively.
Strategic Debt Payments: The Avalanche and Snowball Methods
There are two popular strategies for paying off debt: the avalanche method and the snowball method. Some may prefer the satisfaction of quickly clearing smaller debts, while others might focus on the long-term savings of the avalanche method.
The avalanche method involves paying off debts with the highest interest rates first, mathematically saving you the most money over time.
The snowball method, on the other hand, focuses on paying off the smallest debts first, providing psychological wins that can motivate you to keep going.
Dual-career couples might benefit from a hybrid approach. Discuss which method feels more motivating and aligns better with your financial goals and psychological needs.
Long-Term Savings and Investments: The Future Matters
While paying off debt is important, neglecting long-term savings and investments can jeopardize your future financial security. Retirement savings, in particular, should not be put on hold for too long, especially given the power of compound interest.
Contributions to a 401(k) should be maximized even when you're paying down debt, especially if matched by an employer.
For dual-career couples, consider diversifying your long-term investment strategies to reflect each partner's risk tolerance and time horizon. Regular discussions about financial goals and retirement plans are crucial in aligning your saving strategies with your life goals.
Making the Decision Together
Financial decisions in a dual-career household should never be made in isolation. Regular financial meetings, often called Money Dates, where both partners come prepared to discuss and review financial statements, can help make these decisions more democratic and transparent.
Tools like budgeting apps or spreadsheets can help you track debts and savings, providing a clear picture of your financial landscape.
Wrapping it Up: Balance and Communication are Key
Ultimately, deciding between paying off debt and saving money isn't an either/or scenario. It's about finding the right balance that allows you to reduce debt, save for the future, and still enjoy your present life.
Effective communication and regular financial reviews are the bedrock of successful financial management in any dual-career couple's life.
Remember, every couple's financial situation is unique, and what works for one couple may not work for another. Tailor your approach to fit your specific circumstances, and don't hesitate to seek professional financial advice if you're unsure about the best strategy for your situation.
Working together and making informed decisions can ensure a stable and prosperous financial future.
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