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In Recession, Save Cash Before Paying Debt: Do You Agree?

At first, I was shocked to read that Suze Orman is recommending you pay only your minimum credit card payments and instead save cash in an emergency fund. It’s a total about-face from what Suze and probably 98% of personal finance writers typically recommend: above all else, get out of debt. But, given these unprecedented economic times, I think I agree. Do you?

There’s still no question, credit card debt is financially debilitating. Getting free of debt should be on top of everybody’s financial priority list. But today, due to the troubled economy, saving an emergency fund may be even more important.

Why Save an Emergency Fund Before Paying Debt

In a normal economy, when you are paying down a sizable credit card debt, you won’t have much, if any, cash on hand in an emergency fund. You’ll essentially be broke (no matter how much income you earn) until all the debts are gone. But in this situation, if an emergency comes up, you could—if you really had to—use a credit card again to bail yourself out (knowing that you’ll continue to axe away the debt).

Problem is, the credit card companies have changed the rules. Credit card issuers today are cutting credit lines, canceling accounts, and rarely issuing new cards to anybody with preexisting debt. Put simply, it’s not safe to rely on a line of credit for emergencies anymore. (This is also true for anybody that uses, for better or worse, a credit counseling (or debt management) program. Those programs often request that you cancel all credit cards when you enroll, making emergency savings essential).

For everybody else, even if you have available credit today, it could be gone tomorrow. Put another way, if you used all your money to chip away at a $5,000 credit card balance, freeing up a $5k credit limit for emergencies, you may not be able to use that credit if you lose your job next week.

For the time being, it may be better to pay your credit card minimums and sock everything else away in a high yield savings account (preferably one that you don’t access unless you absolutely need it). Suze says you need eight months of living expenses. If that’s too high of a goal, start aiming to save one month, then three, then six, and finally eight; or determine exactly how much of an emergency fund you need.

Yes, diverting money from paying down debt into an emergency fund will cost you money (in the additional interest you’ll pay on the debt) and may postpone your long-term financial goals. It could, however, help you avoid financial disaster if you lose your income. On the upside, when things turn around and you can feel more secure about focusing on debt reduction again, you’ll have a big pile of cash to help wipe out that debt.

What Do You Think?

Is this a good idea, or would you focus on debt reduction no matter what?

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. woow,im going to have to rethink some things. I was definitely aggressively trying to get rid of CC debt… .

  2. I see the point, but I just can’t agree. Paying credit card interest can yield no positive results and if you continue to pay the minimum that interest will cripple you for years. I think the average person seeing their debt actually rise due to exorbitant interest rates, would get overwhelmed quickly.

    I think a pragmatic approach is best – focusing on one card at a time perhaps – of course starting from highest interest-rate bearing accounts and working downward.

    The only way I can see this being effective is with a card with an exceptionally low interest rate or if one can take advantage of any balance transfers.

  3. thrifty me says:

    I agree with your post completely. While I think making the minimum payment on a credit card is never good, it is more imperative to have savings for an emergency. Not only will an emergency fund give you peace of mind but will also provide greater financial stability. After an E.F. is established then it is good to increase payments to the smallest debt or the one with the highest interest rate.

  4. I’ve been going back and forth on this since I started getting serious about my finances (about 6 months ago). Suze’s book “Women and Money” actually helped put me on the right track. Though I modified the demand for 8 months EF to do something I could do.

    I was aiming for 3 months, while paying off CC debt would still take a couple years.

    I adopted Dave Ramsey’s Total Money Makeover Baby Steps of putting away my first $1,000 while concentrating on CC debt. Though I modified it, I have not stopped funding my EF —- it is a behavior I want to become automatic, like breathing :) But I have lessened the payments while I attack CC cards.

    I’m a contractor, so once I know my contract is renewed for at least one more fiscal year, I can concentrate on the cards which should be paid off completely by the end of 2010!

  5. I agree with her standpoint on this, especially during these times. because your emergency fund can be literally a life saver and cannot be taken away from you. Not having CC debt, while nice, doesn’t amount to much if you lose your job and have to eat, pay bills, etc if you cannot use the credit again. And you cannot assume that credit will be there if you need it. The EF will always be there.

    And the bottom line is, if things get really bad, that CC debt can go bye bye with bankruptcy. sure, it kills your credit and all that, but when it comes down to it, which would you rather have if you could only have one, a nice credit score or the basic necessities of life?

  6. Yikes! This idea of stashing money in savings while sitting on a credit card debt of two or three or five times the interest is frightening to me. I have an IRA that I could withdraw from in the event of an extreme hardship. I’ve thought this issue over a couple of times myself and have decided to keep paying down debt, and take my chances. Some good news from my broker yesterday that they’re forcasting an upturn in markets in September and Economic recovery beginning in December is enough to keep me going ahead. Also, I’m self-employed in a recession-proof business, and DH works for the government. While our income isn’t guaranteed, it’s still relatively stable.

  7. I’ve been thinking about this a lot lately since I recently took on a high interest car loan and wanted to pay it off quickly. I’ve been making two or three payments a month, but not saving anything except for my 401K.

    I believe almost any of us could lose our jobs at anytime right now.
    I think it’s dangerous not to have at least a couple of months expenses in cash.

    I’m going to limit the car payments to two a month and put the difference
    in my savings account until I reach two months. Then I might divert some back to the car loan while continuing to build the emergency fund.

  8. I wrote about this topic at Qvisory http://qvisory.org/posts/emergency-fund-takes-precedence. Maybe, paying the minimum isn’t enough, but how about a little over (the minimum) each month, and then the rest towards the emergency fund…

  9. I continue to attack my debt as a higher priority than building my emergency fund at a faster rate. I would possibly start by saving 1 month of expenses in an EF while paying the minimum on the cards, but then decrease the monthly contributions to the EF once that small buffer is built. Don’t actually stop contributing to your EF all together, but reduce the amount…maybe $50 a month? And absolutely make the saving automatic. Set up a separate direct deposit from your employer (if that is an option) that goes directly into your EF. Paying off your debt faster will save you alot of money in the long run.

  10. I think the point is that you must prioritize your paycheck. There is no reason to worry about interest rates and credit scores, if you are eating out of a trash can because you lost your job. Make sure you have enough liquid cash on hand to “survive” the current economic emergency. Once the economy is better and we have employment security credit card is the next priority.

    -Dan Malone-

  11. Suzan orman is confused.There is notting better then been debt free.take the chance, pay your credit card first before you save.

  12. I am totally agree with you,if we do not have money how can we pay off debt.

  13. Save some cash! My wife was just unemployed for 3.5 months. I saw it coming and started paying only the minimum payment on our card and using it for everything. This enabled us to pay our rent, car payment, and utilities with cash and not have to worry about calling the landlord to explain why we couldn’t pay rent. Had I paid the cards in full, I would have been screwed. She just landed an excellent job and I got a raise, so by the new year the debt we accumulated should be paid off. Disaster avoided.

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