Jeff

I agree with the mathematics of your argument, however there are some expenses that need to be paid in cash and people with financial problems might have already used ther cash advance limit on their credit cards. I think it is prudent to have a small emergency fund for things like rent or home repairs that just can’t be paid by credit card. Plus I think for many people using the credit card is addictive and once you start charging for emergencies it is easy to use it for day to day expenses.

Great article. But what if I have say $3000 on a 0% APR card for 1 year or so. Isn’t it better to just keep paying the minimum and use that money for emergency fund or investments?

Wow, you sure went great lenghts to explain your point of view. The question may not really be that cut and dried, though. Each individual’s circumstances are different and there may not be one right answer for everyone. Thought provoking stuff!

The “credit-card debt before savings” argument has always seemed very straightforward to me, but right now DH and I are trying to figure out the answer to the “student loan or savings” question. The interest rates are much closer, which makes the financial advantage much less clear, and unlike credit cards, if we have no savings and disaster hits, we can’t just tap our student loans for more funds. Right now we’re compromising with a fifty-fifty split of our extra funds.

Ah, the things we ponder.

Good example…you might want to throw in what each paid total to their credit card company in all scenarios

“I agree with the mathematics of your argument, however there are some expenses that need to be paid in cash and people with financial problems might have already used their cash advance limit on their credit cards. I think it is prudent to have a small emergency fund for things like rent or home repairs that just can’t be paid by credit card. Plus I think for many people using the credit card is addictive and once you start charging for emergencies it is easy to use it for day to day expenses.”

Obviously if someone has a large amount of credit card debt, there is a financial problem that needs to be resolved. While I understand what you’re saying, I would counter that by paying down the credit card debt it will open up the cash advance limit (in case there is an emergency) and it is just as easy to begin using your “emergency fund” for day to day expenses as it is a credit card.

My point is that when you have credit card debt, you really can’t have a true “peace of mind” and in many cases it’s detrimental to your finances to build an emergency fund and think that it is helping you financially.

“But what if I have say $3000 on a 0% APR card for 1 year or so. Isn’t it better to just keep paying the minimum and use that money for emergency fund or investments?”

Of course you’re talking an entire different ball game in this situation.

“The question may not really be that cut and dried, though. Each individual’s circumstances are different and there may not be one right answer for everyone”

I completely agree. I would never suggest there is a single answer for anyone and it is always important to take into the particulars of your situation when making a financial plan. I just feel that there are a lot of people fooling themselves thinking that an emergency fund gives them something that really isn’t there and it’s important to realize how much it costs.

“DH and I are trying to figure out the answer to the “student loan or savingsâ€? question. The interest rates are much closer, which makes the financial advantage much less clear, and unlike credit cards, if we have no savings and disaster hits, we can’t just tap our student loans for more funds. Right now we’re compromising with a fifty-fifty split of our extra funds.”

Certainly the interest you pay on the debt makes a huge difference as the 0% credit card comment would indicate. You are also correct in that unlike paying down credit card debt which frees up your limit, paying student loans and other debt does not allow you to take that money out in the instance of an emergency - and you are wise to try and balance it.

Credit card debt is the devil I’d prioritize getting rid of it. Take a night and weekend job. Just purge that debt.

[…] Credit Card Debt vs Emergency Fund by Jeffrey Strain at Personal Finance Advice looks at whether you really have an emergency fund if you have credit card debt. […]

I think it’s good to pay down credit card debt, especially if the interest rates are high. Or better yet, use 0% balance transfer like Floyd mention to pay down the debt. Like you said, the emergency money in the bank is not really emergency money because you still owe the money and paying high interest rates compared to the bank.

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To the first commenter (John Mackenzie): you’re absolutely right, some things such as rent do need to be paid in cash rather than put it on credit card in the event of an emergency cash shortage. But you can still put all your savings into paying off credit card debt rather than building up an emergency cash fund - apply for a line of credit. This can be your “emergency fund” until you have paid off the CC debt. If you don’t use it, it costs you nothing. So, only use it if you literally RUN OUT of cash due to emergency.

Ah, the long-debated issue of credit card (or bad) debt vs. savings (or emergency fund). We’ve all heard the saying “pay yourself first“.. so why aren’t we doing that in this situation? The commenters above have brought up excellent points, including the comparison between APR interest rates being charged on the CC (or other debt) versus APR yield of a savings account, for example, as well as different circumstances where drawing off the line of credit would be impossible or unprudent.

The theory behind Jeffrey’s article is simple. You want to allocate your money (income and savings) toward the investments that will yield you the highest rate of return. Unfortunately, credit card and other bad debt is actually NEGATIVE (-) return. So if you’re paying off a credit card with say, 10% APR, any money you place into another investment such as a savings account or stocks, for example, would have to ACHIEVE a 10% APR yield in order for you to just BREAK EVEN, not including transaction costs, etc. As such, the best idea is to pay off your NEGATIVE return items as fast as possible, fighting the power of compound interest that the credit card companies will charge you. The more money you put in the credit card, (1) the less interest you will be charged per month, so you will be able to in effect ’snowball’ your payments as more and more of your monthly payment is applied toward the principal, and (2) the faster you pay it off, the sooner you can invest into positive-yield items such as a high-yield savings account for those emergencies, or into an investment portfolio. Thus the scenario Jeffrey mentioned above.

Now, in addressing the exceptions to the rule and the issues brought up:
1. John Mackenzie mentioned the fact that yes, some things in life requie cash. And also brought up the prudent point (albiet indirectly) that perhaps using your CC’s CASH AVANCE may be a BAD IDEA. Why? Because most credit cards will charge you way HIGHER interest for that cash advance, and guess what? The tiered payment setup that they use to maximize their gains is that any principal you pay on your credit card will get applied to the purchases with the LOWEST APR. So even if you have for example a 0% APR card and its filled up halfway, but you do a CASH advance, guess what? Your payments won’t go toward your high-intereset cash advance, but toward the 0% balance you owe first. *NOTE* Check with your credit card company for the specific details, but that has been my experience as well as many people I know.
Solution: Develop a budget. Rent should not be an “emergency” because you should have already accounted for that in your monthly budget.
2. Addressing the issue of 0% APR furthermore: Yes, if your credit card has 0% APR, and your balance is fully within that 0% APR, then using the best investment yield rule mentioned above, YES. Pay only the minimum amount (for which each payment would go toward the principal) but DO NOT charge anything else or cash advance on that card. If you do, you will start carrying a negative APR yield in the form of interest owed. While you’re paying off the minimum, you can look for a high-yield savings account for those emergencies and start stashing away.
3. Student loans/non withdrawable debt: On the surface, this would appear to be a tricky subject. But as the posters above mentioned, it is best to balance your budget to include payments in while working on your emergency fund savings. If all payments went toward the loan, and you hit an emergency, you might have to take a high-interest loan to pay it, which would be counterproductive. So it only makes sense to balance your payments. Plus those loans tend to have lower interest than credit cards.
4. Laura’s comment about APPLYING FOR A LINE OF CREDIT. Unless the emergency comes and there is absolutely no alternative (re: borrowing from family, friends, or even *gasp* using the CC), I would not recommend it. Why? Because the last thing a creditor wants to see is someone who owes a significant amount of money in the form of credit cards apply for MORE credit. It can hurt your credit score, which can have long term consequences. NOTE: Again, check with a financial advisor or credit reporting agency for how this applies to your situation.

Long comment, I know.. but here’s the Cliff notes
1. Develop a monthly and yearly budget which includes payments for living expenses such as rent, phone, utilities, etc AS WELL as credit card and other bad debt. Also include a section in the budget for “savings” or “emergencies”. Now you know how much you absolutely need to spend every month. Allocate any windfall cash or spare money toward the highest-interest debt. Furthermore, create a debt-amortization schedule, so you know how long, with your current monthly payment, it will take to pay off your debt.
2. Always pay off the highest-interest debt first.
3. Stop the bleeding. Don’t charge any more on your credit card, especially if the new charges will have higher APR interest.
4. Stick to your budget.

It’s amazing how much BAD advice you can get out there on the internet from people who are far from being experts themselves. They say…..Don’t pay off balances in full at first in order to build credit, get a few store cards, etc….

This article spells out the truth, plain and simple. It’s nice to know that among all the bad advice, there is some good advice as well.

This is somewhat of an age old battle in the personal finance arena, emergency savings vs paying down credit cards.

I’m a big believer in doing whatever it takes to smooth out “CASHFLOW” which generally means having at least 1 months worth expenses saved up in cash. So that you always have a buffer that you can rely upon without having to once again dip into your credit card to bail you out.

I think that is the danger of not having a emergency cash fund, without something to back you up if your cashflow gets thin then it’s a big temptation to draw on your credit card limit that you have worked so hard on getting down.

If you have high interest credit card debt you need to get that paid off one way or another before the emergency fund. If you really want a smack in the face as to how much you are losing in cc debt each month goto bankrate.com and use the minimum payment credit card debt calculator. It is a big eye opener to the length of your debt and the money going towards interest.

This is 100% dead on except for a couple things!
1- Age and financial goals. If you already have a home and a plentiful retirement go for it. Pay off your debts. If your an Xer do not listen to any of this. Get the savings you need to purchase a home then concentrate on paying off the debt. Do not apply for a home loan until that debt is $0. I did this and I have to say it works out the best for us. Unless of course you have so much debt that you can’t save. Then I would suggest getting some financial help.
2- If your a boomer and have very little to live on and are ready to retire soon. Survival comes before any credit card, car loan, or any other debt you can think of. Put your self first not your debt.
3- New parents you may have made bad financial decisions but don’t make your kids suffer for your mistakes. A college fund comes before all debts. They are you and your future.
Many of you will hate me for this but the fact is money isn’t everything people are what makes this country great. People are the key here and a factor that is offten lost. Sometimes the numbers make sense but the fact is sometimes you have to put the good of others ahead of yourself. Good luck

The article was timely…for me…as I am struggling with the decision of whether to pay off debt first or create an emergency fund first.

I also agree with Steve F that what is important here is people. What is even more important is for people to analyze their relationship with money…in whichever form, for therein lies the culprit. If people can be honest with themselves and go back to that point in time when they started using credit cards and how they eventually ended up swimming in debt, they will be able to tell if they have a healthy, or unhealthy relationship with money.

Of course there is always living below your means and not placing our happiness in material things…. or in other people. We have all the answers, sometimes we just don’t ask the right questions.

[…] circumstances. One readers explains hers and is looking for advice: I just read your post about credit card debt vs. emergency fund. I completely agree with the concept and appreciate your example. I like numbers and they really […]