Not panicking, just refining my strategy.

October 2, 2008 2:14 PM

Given the current economic climate, should I be padding my emergency fund or paying off my credit cards?

For the past year, I've been aggressively paying down my credit card debt. At the beginning of the year, I had several credit cards, all carrying a near-maximum balance. Now, I've completely paid off the card with the highest interest rate, and I'm within striking distance of paying off the whole thing. Yay! I estimate that within 4 months, I'll be credit-card-free.

In the meantime, I've been making very small but steady payments into an emergency fund. This fund is now large enough to cover about a month of living expenses.

I haven't been too worried about the economic crisis so far, because I don't really have enough money to be directly affected. But I work for a small business -- exactly the kind of business that might be harmed by the credit crunch. As far as I know, my employer is doing just fine, but I'm a little worried about what might happen in the months to come. Because of this, I've been considering temporarily switching back to minimum payments on my credit cards so that I can build up my emergency fund to a more comfortable level -- maybe 3-4 months' worth. Is this a good idea?

A couple of other factors to consider:

- In addition to the credit card debt, I have subsidized student loans, which I've just been paying minimums on. I figure I'll be paying these off for the next few years, but the interest rates are so low that I don't mind.
- I also have an "irregular expenses" fund that holds enough for things like doctor's appointments, car repairs, etc. So my emergency fund is strictly for emergencies.

So, what do you think? Given these conditions, should I be putting more into my emergency fund? If the economy goes "plop" and takes my job with it, will I be better off with more cash on hand, or will I be regretting not paying off my credit cards when I had the chance?

Thanks, all.

posted by ourobouros to work & money (17 comments total)

Credit cards.
posted by rokusan at 2:20 PM on October 2, 2008

If I suddenly became jobless, having outstanding debt would make me much more uncomfortable than having little cash on hand. There will always be shit jobs in a pinch, and in your worst case scenario, what little money you'd make from such a job would go a lot farther if you had no credit card debt.

Personally, I think we'll all be a whole lot better off if the economy takes the whole personal revolving credit system down with it
posted by M.C. Lo-Carb! at 2:21 PM on October 2, 2008

personally I'd be more focused on eleminating debt.
You could do half and half....
posted by nickthetourist at 2:22 PM on October 2, 2008

I'm with the eliminating debt crowd generally. One cavaet: I'd consider trying to pay off all of one card while paying the minimums on others, so then once that card is paid off you have a "grace period" again to help with cash flow.

I'd also look at if you have any reoccuring expenses you could cut down. (Say switch from a monthly cell phone to prepaid minutes, though that may not work if you use a lot).
posted by ejaned8 at 2:27 PM on October 2, 2008

Credit cards, especially if the cards are variable rate. You can expect your rates to skyrocket if the bottom falls out (which would wipe out some of the payments you've already made), but if your cards are paid off you won't have to worry about that.

If you get laid off, there is unemployment to help with living expenses, but no one will be helping you with your credit card debt.
posted by lunasol at 2:39 PM on October 2, 2008

I think it depends on your income, and what you'd receive in unemployment in the event of a layoff. Would it be enough to meet expenses and pay all your minimums? Then focus on debt. But if it *wouldn't* be enough, then I'd want more than a month put away. Also - how honorable is your employer? It's not unheard of for small employers to pretend it's a cause firing in order to deny unemployment benefits... it'd probably get straightened out, but if you don't trust your employer to acknowledge the layoff, then it'd take more than a month to get your benefits. Given that you work for a small business, I'd want more than a month's work socked away.
posted by moxiedoll at 2:47 PM on October 2, 2008 [1 favorite has favorites]

As you pay back these cards, you will probably be able to borrow against them again in case of emergencies. While this isn't guaranteed, if you put the money into savings instead of credit cards, you are guaranteed to pay extra interest. So I'd probably pay off the cards first, then build up the fund, then pay off the student loans if it makes sense otherwise.

One of the reasons to have an emergency fund is so that you won't have to go into debt for the emergency. You're already in debt.
posted by grouse at 2:48 PM on October 2, 2008

Credit cards. The way I always look at these things is to compare interest rates. The only time you should choose saving money over paying off debt, is if your savings account earns more interest than your debt costs (eg if you had a 0% financing on something). Based on typical assumptions, your credit card has the highest rate of interest, then your savings account, then your student loans (I'm not a USian so I might be wrong about your student loan rates, but whatever, you get the idea!).

Therefore, pay off credit cards first, then save money, then pay off student loans on schedule instead of early.
posted by Joh at 3:18 PM on October 2, 2008 [1 favorite has favorites]

nthing pay off the cards; it's not even close.
posted by Perplexity at 3:44 PM on October 2, 2008

The problem with euphoria, and the inevitable crises that follow, is that people swing from one absurd notion to another, instead of seeing the middle ground. About a year ago, people were preaching that debt was good; that it was okay to take equity out of your home; that living in debt was okay. Now, people, scared shitless, think that debt is evil. Never live in debt. FEAR debt.

You know what I fear? Being unable to pay for rent, food, and gas for an extended period of time, should I lose my job. If you don't have 3-6 months of CASH, hard, deliverable, cold cash, you're in trouble. In normal circumstances, you can't pay rent in credit. Additionally, if suddenly the bank says that you're a liability and shuts off your credit, and you have no cash, how do you survive (sidenote: the frozen money market, and GE raising capital, are examples of needing cash and not being able to get it, and getting it, respectively)?

Paying interest on credit cards sucks. But when employment suddenly becomes a variable, as opposed to a certainty, you need CASH to get you through the down time. Sure, you can always get a quick job where you may be underemployed. But in the weeks that it takes to find that job, how are you paying your bills?

Too much debt is bad. Credit card debt is bad. But always, always have an emergency fund that can get you 3-6 months of breathing room. That's a necessity, and will be far more valuable than the saving a couple of bucks in interest payments to your credit card companies.
posted by SeizeTheDay at 4:01 PM on October 2, 2008 [3 favorites has favorites]

Vote here for paying down the credit cards. Then use the money you were putting towards that debt into building your emergency fund. Don't be tempted into spending the extra cash on frivolous items.
posted by arcticseal at 5:40 PM on October 2, 2008

I agree with SeizeTheDay. ALWAYS have at least three to six months worth of cash in an easily-reached savings account before you do anything else - your job could disappear in one meeting. Hell, it's happened to me four times in a decade - and I'm a good employee!
posted by almostwitty at 5:57 PM on October 2, 2008

SeizeTheDay, almostwitty: If ouroboros had started with no debt, and enough money to pay monthly expenses but no more, would you advise taking on new credit card debt in order to build up the emergency fund?
posted by grouse at 6:04 PM on October 2, 2008

That's a great question, though tricky.

Everyone needs something called working capital. Businesses and persons alike need access to a pool of cash at all times to be able to meet their regular obligations. Businesses are lucky in that they usually have inventory, or lines of credit, or accounts receivable to keep them alive when times get tough. People are not so lucky. We can lose jobs on a whim (because most people work at will), and unless eligible for unemployment, have no real access to cash except for our savings. We aren't well protected, and there's no real safety net. This isn't a political spiel; it's a fact. This country does not take care of its jobless or homeless very well.

To answer the question, if a person has a college education, normally banks allow you to ask for personal lines of credit that are backed by your education. I think that if you have absolutely no savings and no debt, having this line of credit is a lifeline that protects you in case disaster strikes. But if you don't have a college education, yes, a credit card is your lifeline in case disaster strikes. So would I borrow $X from my credit card, stick it in my checking account, and pay it off in four months with future earnings (as the OP has suggested is possible)? Yes, absolutely. What is the borrowing cost for $X? It is 1/3*APR*$X. That's a fractional cost compared to the risks you take by not having any cash on hand.

The above scenario assumes that you have restraint when it comes to your spending habits (i.e. you won't piss away all of your "newfound" money). It also assumes you don't have access to a line of credit.
posted by SeizeTheDay at 6:28 PM on October 2, 2008

One thing to consider, once you've paid off all of your credit cards, it's REALLY hard to let yourself use them for anything you can't pay off right away. It took us years to pay off $10,000. When there was still $1500 or so on the cards, it was easy to say, "Oh, another 100 or two won't make much of a difference." and start charging them back up. Once we actually got to Zero, it was too nice a feeling to jeopardize.
posted by artychoke at 9:13 PM on October 2, 2008

Come on!!

Unless you have just done a grace period balance transfer on your Credit Cards then you are being charged between 10-20% p.a. on your Credit Card balances.

Your Emergency Savings and Other Positive balance accounts would be lucky to be earning 3-5%p.a.

So effectively you are loosing upto possibly 15%p.a. on the balance in your Emergency Accounts by NOT using it to pay off your Credit Cards completely.

you should empty all your accounts to pay off any interest earning Credit Card Balances. If you have an Emergency, payfor it by Credit Card, you will then get a month interest Free on those New Credit Card purchases during which case you can try and find the cash to pay the emergencies off.

Student Loans should be accruing interest at approximately a deposit rate so there's not much point payign those down until after you have paid all your credit card debt.
posted by mary8nne at 3:25 AM on October 3, 2008

Whats up with you people 3-6 months worth of Cash?!! what for? you are just throwing away your money with interest.

Pay off your credit card Debt but Keep the cards for use in an emergency. It works out the same. BUT you are maximising the time value of your money.
posted by mary8nne at 3:29 AM on October 3, 2008