Couples can navigate around perils of debt

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Author: John Waggoner

Section: Money, Pg. 03b

For many couples, it's a familiar dilemma: You've got debt. You don't have much savings. And you have a bit of extra money at the end of the month. Should you pay off your debt or add to your savings?

Both, experts say. Having emergency savings is your best protection against running up debt. And paying down high-interest debt is probably the best investment you can make.

Debt ...

For Juan Salazar of Mesquite, Texas, the choice between debt and savings is easy: Pay off debt. He and his wife, Elizabeth, have about $25,000 in credit card debt.

Salazar, 32, who is self-employed, owns First Choice Paint & Body Shop in Terrell, Texas. Elizabeth stays home with their two children. They had no health insurance when they had their second child, so they had to pay most of their medical bills through credit cards.

Monthly credit card payments are $900 a month. "I'd rather pay off my debt than keep a savings account," he says. "If there's nothing left over, that's fine as long as the debt is gone."

For the Salazars, it's a wise choice. The return on paying off debt is roughly equal to the interest rate you pay. Many credit cards charge 18% or more: You'd be hard-pressed to find another investment earning 18%. "It's like giving yourself a risk-free 18% return," says Don Lutomski, a financial planner in Birmingham, Ala.

Consider a couple with $10,000 in credit card debt. They paid 18% interest. The credit card company requires them to pay at least 4% of their balance each month, or $35, whichever is larger. If they paid just the minimum, they'd be paying for more than 10 years. Total interest: $5,575.

But if they paid $100 more than the minimum each month, the couple would end up repaying the entire balance in 50 months, a bit more than four years, saving $2,285 in interest. Best of all, they would have wiped out their debt, boosting their cash flow by $265 a month.

By contrast, the returns from a savings account seem paltry. Had you stashed your $100 a month into a bank savings account paying 5% for 50 months, you'd have about $5,424 in your account at the end of the period. You would have earned just $425 in interest.

... vs. saving

But don't downplay the importance of savings. Most people who've amassed high credit card debt did so because they didn't have any savings, says David Jones, president of the American Association of Independent Consumer Credit Counseling Agencies.

A flat tire, a broken water heater or an unexpected medical bill can send your debt spiraling. "It's important to have a nest egg so that if something unforeseen happens, you don't have to pay for it with debt," he says.

The worst-case scenario: You lose your job at a time when you've built up no savings. "It takes about one month of job search to replace each $10,000 of income," says Gail Cunningham of the Consumer Credit Counseling Service of Greater Dallas. Unless you have savings, your debts will mount rapidly.

Most experts recommend you put aside three months' worth of expenses in a safe, liquid account, such as a money market fund, in case of emergencies.

Balancing act

Your best strategy: Build up your savings at the same time that you pay down debt. But where's the best place to save? And which debts should you pay off first?

Let's start with savings. Ideally, Cunningham says, you should save 10% of your pay. "That leaves 90% for everything else," she notes. And if you do save 10% of your pay, you'll have a bit more than a month's worth of your pay in the bank after one year.

Make an emergency fund your first priority. Then contribute as much as you can afford to your company 401(k) retirement plan, particularly if your employer matches your contributions. "If your employer is going to give you money, you almost have to do that," she says.

Contribute to a retirement plan before you sock money away for your children's college. The kids can get student loans or work through college, if they must. You can't get a retirement loan.

Start small if you want. Most banks will let you start small savings accounts. And some mutual funds will let you start an automatic investment account for less than the usual minimum initial investment. The fund will tap your bank account electronically each month. Five top-performing funds that will let you start an automatic investment program for $100 a month or less are in the chart.

But starting a savings plan isn't enough. You have to address your debt, too. Artie Farve, youth minister for the Christ Community Church in Ardmore, Okla., is on track to pay off his $8,000 credit card debt by next year.

One of the first steps Farve and his wife, Jennifer, took: "Stopping up the leaks," he says. The leaks, in their case, were late fees, over-limit fees and punishingly high interest rates. "We weren't doing anything but throwing money in that direction," Farve says.

Once you've gotten your payments on schedule, choose your biggest debt with the highest interest rate and start paying it down. Most times, that's credit card debt. If you can qualify, switch to a card with lower rates. Just don't succumb to the temptation to use the card more frequently. A list of credit cards with low rates is in the box.

Put paying off your mortgage early low on the priority list, Jones says. In most cases, your rate will be low, and your house, over time, will grow in value. And unlike other interest, mortgage interest is tax-deductible if you itemize.

The Farves are putting nearly all their money into their credit card payments. But they're also putting $50 a month into savings. "Our immediate goal is to have $1,000 in savings," he says. Once their debts are paid, the Farves want to ramp up their savings until they have three months' of living expenses in the bank.

The Farves got help from a non-profit consumer credit counselor, who helped them negotiate lower interest rates on their debts and set up a payment plan. They had tried to do both on their own, to no avail.

By saving a bit and paying down their debts a lot, the Farves hope to be on solid financial footing soon. It's a strategy that can help most couples, even if they're not worried about debt.

But it never hurts to worry a bit about debt, Farve says. "At the first sign of problems, don't ignore it," he says. "Get help."

TEXT OF INFO BOXES BEGINS HERE

Savings plans for really small investors

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Lowest-rate credit cards Standard credit cards with the lowest rates:

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Couples and their cash

In a series that continues weekly, USA TODAY is exploring the ins and outs of couples' finances. Each Monday, we're profiling one of five couples who agreed to a Money Makeover from USA TODAY and the Financial Planning Association. Each Friday, we're covering couples' most pressing financial issues and offering advice on how to handle them.

(c) USA TODAY, 2006