14

Is there a rule of thumb or basic idea as to how much savings I should keep regardless of credit card debt? Right now I have about 5k of CC debt at 17% and 5k in savings....seems like a no brainer right? But at the same time I feel like I would be awfully nervous if I had no money in savings in case of emergency. I have a mortgage, car payment, etc...how does one walk the line between being safe and doing what makes sense financially in the absolute sense?

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    It blows me away that you have a mortgage and a car payment...and no savings ($5k - $5k in debt = $0), and yet you are now concerned about "being safe". Everybody's risk setting is different, I guess. – Chelonian Nov 6 '11 at 3:13
  • I'm 26...kind of rushed into buying a house which needed a lot of improvements. I guess worst case I could always tap my 401k which has built up quite a good bit... – GBa Nov 7 '11 at 14:57
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    I'd focus first on savings rate. Figure out how much you can save--hard money in the bank--per month, and then figure out if there are good ways to increase that. Can you earn side money somehow? Can you cut your $2.50/day Starbucks habit? Can you buy in bulk? Eat more rice and beans? Can you live without cable? If you can eke out $50/wk more in savings, you are more than halfway to replenishing the $5k you have to tap now by this time next year, just on that alone. It's definitely do-able. Good luck! – Chelonian Nov 7 '11 at 17:37
  • @Chelonian Stuff happens... medical bills, bad luck, etc. I have a mortgage and car payment... no savings... over $10k in CC debt @12%, $130k on my wife's student loan which I am making payments on because she can't work. To me, even trying to save anything before all this debt is paid off, I just don't see how I could do it. – Andy Oct 2 '15 at 1:37
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Assuming you would still have a line of credit, it makes plenty of sense to pay off the loan. You're paying 16 percent for money you don't need right now. Pay it all off and you can start rebuilding your savings account.

So what do you do in a future emergency? Well first off, you can use the savings you have rebuilt up to that point to fund some portion of it. The rest you can borrow again, as long as you have a line of credit somewhere. The icing on the cake though, is that once you stop carrying a balance, your credit card purchases will have grace periods again. Once that grace period kicks in, it's an effective short term free loan, and if you really wanted to, you could move money that would otherwise immediately go to purchases into savings. The difference is that you're paying in full again, and aren't charged any interest on the float. Just remember, that if you fail to pay in full by the due date, they charge retroactive interest and fees.

An alternative is to find a way to consolidate your credit card bill into a collateralized loan. HELOCs for example. The rates are much cheaper than your CC bill, but require you to have some equity in the home. One thing to consider is that HELOCs are an open line of credit that can't be easily taken away. The interest is also tax deductible, unlike your credit card interest. There's also unsecured lines of credit from banks and credit unions, and if you have the credit score the can be cheaper than credit cards.

I think I've shown here that there's plenty of alternatives to carrying credit card debt for the unexpected in life. Pay it off!

14

I would not go down to zero cash on hand. I would keep $1,000 on hand and pay off most of the credit card balance.

Then I would pay off the last $1,000 on the credit card followed by building my emergency savings back up.

10

As long as you can get a cash advance on the credit card if you need it, then you're not putting the money beyond use if you use it to pay down card debt, you're just putting it where it gets the best rate of return.

8

You're paying $850/yr interest, and probably earning close to zero on the $5000 in savings. I don't know why this feels safe in comparison to having both at zero, and depositing the payment you now make to the card into savings. Even if the payment is just $100, you'll have $1200 in a years time. I don't know of an emergency that can't be handled on a credit card, and I'd go that route until you build up a decent real emergency fund. I wouldn't offer the same advice if the debt were low rate loans such as your mortgage or student loan, but 17% is high enough to do it this way.

7

In your scenario, I would do the following:

  1. Immediately pay off the credit card.
  2. Remove the credit card from my wallet.
  3. Set a goal to rebuild the $5000 over a sensible time frame. (<1 year)

If, in the short term, something should happen, you can always tap into a line of credit or even a cash advance on the credit card. But, you should in no way be paying $70 a month in interest.

Assume you want to pay off the Credit card over 12 payments, you would need to pay about 450 a month, which costs 400 in interest. At the end of the year, you have $5000 in savings, and $0 debt.

The alternative, is to pay off the credit card right now, and put that $450 into savings, you would have $5400 in savings, and $0 debt.

I'm usually the last to recommend a $0 safety net, but I make an exception in the case of retirable credit card debt. In the worst case, you are no worse off than you are now, in the best case, you're up about $400 at the end of the year.

3

I think the answer depends on whether you're trying to get out of debt and stay out, or if you just want this card paid off. That is, are you changing the way you deal with money and debt for good?

If you just want this card paid off, and you're OK with going back into debt later, then @Mike Scott's advice is one way to go. I'd personally be nervous about leaving myself with no cash reserves at all.

If you are planning to get out of debt and stay out, then you don't want to put yourself in a position where you're tempted to go back into debt as soon as you hit a speed bump. So, you need some cushion so that an emergency doesn't push you right back to the credit cards. If you've got a budget that you can live on, and that covers your usual expenses, and your job is relatively stable, then $1000 is probably enough of a cushion for most things. You can then pay off most of the credit card using the rest of your savings. If you're in an unstable job situation, then you'll want to keep more, if not all, of your savings as protection against the instability. Once the situation stabilizes, then throw the surplus savings at the debt.

$1000 doesn't cover all possible emergencies, but it's generally a good tradeoff between prudence and paranoia.

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    So.. it's not okay to fund an emergency by credit card, but it is okay to fund rainy day savings? – jldugger Nov 5 '11 at 18:49
  • @jldugger I don't understand your comment in the context of this answer. Can you elaborate? – Alex B Nov 5 '11 at 20:17
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    By keeping 5k in saving and 5k on a credit card balance, you're effectively funding your rainy day fund with the credit card (since the alternative would be to have no credit card debt and no rainy day fund -- imagine if someone was already in that situation and was asking if they should take a 5k cash advance on their credit card to put 5k into a rainy day fund). – Zach Nov 5 '11 at 21:12
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    My answer is addressing the behavior side of the equation. If @Will Den is trying to break the cycle of debt in his life, then putting himself in a situation where he might have to jump right back in is a bad idea, even if it makes the most mathematical sense. – Randy Coulman Nov 5 '11 at 23:48
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    Your answer isn't bad, but I think the answer to financial illiteracy is to cure the illiteracy so that people can get their psychological boost from doing the thing that makes the most mathematical sense. – jprete Nov 6 '11 at 2:45
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If you have $5k in cash and $5k in credit card debt, you should pay off the credit card and use your line of credit for any emergency cash need.

You're worried about not having cash on hand but that's exactly what a credit line provides. You can draw a cash advance from it if you need. If you pay it off, at least you don't pay interest during the time you don't need it. 17% is a ridiculously high rate of interest.

In actuality, you don't have $5k in savings because if you had paid for your purchases using cash, you wouldn't have the savings. So it's basically like you've drawn a cash advance from your CC company to fill your bank account with.

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