Q: Mr. Money Mustache,
I was curious where you stood on the subject of building up a 6 month savings cushion versus flinging money at existing debt? I know what Dave Ramsay says, but I also value Mr. Money Mustache’s experienced opinion. Thanks!
A: SOME sort of cushion, or ‘stash as we refer to it here, is essential to keep your life smooth even in the event of losing a job or having a big unexpected expense. But it is a huge waste of money to keep money in the bank earning no interest, while paying higher interest on debts.
The solution I like to use is “springy debt”. That is, debt that you can pay off or withdraw from, at will. A credit card is one form of springy debt. A mortgage, on the other hand, is one-way debt, since you can pay extra on the principal, but never suck money back out when needed.
I always set up a line of credit on whatever house I’m living in, and keep its balance at zero whenever possible. And I keep very little money in real cash in the bank – just a few thousand dollars, enough to cover a month or so of spending. Credit cards are automatically paid in full from this account, so it has to safely cover that without going into the red.
Any unpredictable expenses that aren’t covered by the bank account can now come straight out of the line of credit! Most people can qualify for a line of credit big enough for quite a few months of emergency expenses.
Some fancy bank accounts even let you connect a line of credit directly to your bank account. This is even more convenient, as long as the interest rate is still close to the prime rate.
If people currently have unpaid credit card debt, this is much more of an emergency. You DEFINITELY don’t want a cash cushion in this case, because the credit card is already an expensive cash cushion running in the negative. In this case, I’d keep paying off the credit card, and if possible get a line of credit on your house to pay off the credit cards, and then pay the line of credit down to increase your safety margin. And of course, cut spending drastically since unpaid credit cards mean you are walking very close to the edge of a steep cliff!
There will be lots of more detailed posts on dealing with debt in the future, since a lot of Junior Mustaches might be starting out with uncomfortable levels of the stuff.
Am I getting ahead of myself to ask where Mr. Mustache is “stashing” the bulk of his money then? This junior mustache has no credit card debt or car loans. Just a mortgage, equity line, and six figure student loans. Oh and a husband (with a worst case scenario mentality) who is adamant that a 6 month “stash” is necessary before anything else. I kinda think the home equity line should go first, even before replacing the car. Either way, we are currently doing a thorough (and painstaking) review of our finances to see where we are spending our money and because I need to know exactly what 6 months of expenses amount to.