Here’s your ace in the hole for weathering this long recession

Five Cent Nickel published a post that discussed what things to consider when you have both debt to pay and money in the bank.  The main problem is that the difference in what the bank pays in interest is far below what one would pay on a typical credit card balance.  Holding on to a large bank account while slowing paying down a credit card balance means that there are a lot of interest expenses being paid to the credit card company.

Nickel's advice isn't one-size-fits-all, which is good:

… sit down and carefully consider how much money you really need to have sitting in the bank. $1000? Six months of expenses? Twelve months of expenses? The “right” answer will vary. But if you’ve got more than that amount stashed away, use the excess to attack your debt.

Not a thing wrong with this advice.  Some specific questions I would ask as you “carefully consider how much money you really need to have sitting in the bank” are these:

• How safe is your job?
• Do you have an independent source of income, either in a second job or a side business?
• Are you in an industry that is slashing hours or slashing jobs?
• Are you important enough to the revenue stream of your company that your job is safe?
• If you were to lose your biggest paycheck tomorrow, how long would your emergency fund last based on your current expenses?

If you have cash, this is your ace in the hole for weathering a long recession. An excess of money in the bank buys you time to replace a lost income source.  The more cash you have, the more time you have before bad things like late payments, defaults, foreclosure, and bankruptcy happen.

Here's a specific example.  Let's say you have $10,000 in the bank, and $15,000 in credit card debt, at some interest rate.  Your minimum monthly payment on the debt is, say, 2% of the balance, or $300, but let's say you're whittling it down a little faster than that, say $500/month.  Your monthly expenses are $2,000 per month, and you're just about breaking even right now:  outflows match inflows.

So, at the moment, you have enough to cover five months' worth of expenses ($2,000 per month times 5 months = $10,000) should you lose your job today.  You can even squeeze another two weeks out if you cut your debt repayment back down to the minimum.

Now, say instead that you threw $5,000 at that debt.  Your minimum payment drops to 2% or $10,000, or $200, which is great.  But your bank account now stretches less than three months. You have only about half the time to replace that income should it go away.  Not a good position to be in.

Cash in the bank is recession insurance. It does carry a cost if you have debt to pay off: interest spread.  But once you make the decision to pay down your debt with your cash in the bank, it's not available to you anymore. The credit card company won't give it back to you, and if they loan it to you, it will be at very high interest rate.  You may as well start charging on your card again.

People questioned Suze Orman when she advised not paying down debt as quickly as she had advised before, but I don't think it's bad advice at all.  A bolstered emergency fund is an excellent idea in this economic climate.  I might go so far as to say that you can't have enough emergency fund right now.

If you should lose your job, you'll be glad that you have as much as you do.