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?