The following is a guest post from Think Debt Relief.
For years, we’ve heard that we need to have a game plan when paying down our credit card debt: prioritizing our highest interest rate credit cards over the ones with the lowest rates, paying more than the minimum payment each month, making one extra payment a year.
But as this recession continues to claim jobs at an unrelenting pace — wiping out 5.1 million jobs since the recession began last December — financial expert Suze Orman says it’s time to rethink our old views about finding credit card debt relief.
In a departure from the advice she’s advocated for much of her career, Orman says we should make building up an emergency savings fund our top priority instead of focusing on paying off our high-interest credit card debt.
“The sad reality is that the credit card industry is taking actions to protect themselves with no regard to your needs or how good you have been in paying your bills on time,” she says.
Go Into Survival Mode
With the national unemployment rate at 8.5 percent, and with credit card companies making it harder to get and keep credit by shrinking credit limits, hiking up interest rates, and shutting down credit card accounts, it’s more important than ever to have an emergency fund to fall back on, she says.
If we suddenly found ourselves without a job and we couldn’t rely on our credit cards to help tide us over until we found a new job, many of us wouldn’t have the financial means to survive.
To avoid finding ourselves jobless and moneyless, Orman says we should start paying only the minimum on our credit cards and start socking every cent we have. The financial guru suggests that we save away enough financial reserves to get us through eight months of living expenses.
Once we’ve got enough money saved in our emergency account, then we can start making bigger payments on our credit cards.
Three Ways to Start Saving In Case of a Layoff
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Have a firm grasp of your living expenses. Create a worksheet to track how much you spend every month on necessities like rent, utilities, groceries, and gas. On a separate sheet write down your miscellaneous expenses like entertainment and eating out. Once you have calculated your total spending for each sheet, multiply each number by eight — that’s how much you need to find a way to save up if you want to maintain your current lifestyle. If you’re the practical type, then you only need to save up enough to meet the expenses on your first worksheet. Doing this exercise will help you see where your money is going and what you could cut back on.
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Practice living off only one income in a two-income household. Try living off only one salary — preferably the salary of the person with the most job security. The paycheck of the person with the least stable job should be dedicated solely to savings. Building up that nest egg will help ease the financial stress of unemployment and give you greater peace of mind during this recession.
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Explore your debt relief options. Talk to your credit card companies and ask if they offer any repayment options that offer you greater flexibility. If your card issuer is unable or unwilling to work with you, you may want to consider getting the help of a consumer credit counseling agency or a debt settlement company that could help you settle your credit card debt for less than what you owe.
I always had the feeling that those "settle your credit card debt for less than what you owe" advertisements were scams.
Are they an actual legit business?
Posted by: Craig | April 18, 2009 at 11:18 AM
I hope one thing we have learned about this recession is that you can never rely on your income so emergency funds are an absolute must! And everyone should start thinking about diversifying their income, see my blog for this idea.
Posted by: Personal Finance | April 18, 2009 at 02:04 PM
I kind of agree with Orman's main point, that it's time to reevaluate our money priorities during this upheaval - and for sure, it's not over yet - but if you have a credit card with 19% interest, it's still a good idea to try to get rid of it asap I think. But even I have diverted much of my investment income into savings and paying off debt as a result of the economic uncertainty - two practices we should be doing all the time anyway! I guess it's true that it's the hard times that wake people up.
Posted by: MoneyEnergy | April 18, 2009 at 07:34 PM
I like the idea of practicing to live off of one income for two income households.
I have been trying to do this but with student loans instead of credit cards. Minimum payments to the loan and maximum payments to the emergency fund.
Posted by: Cherry Blossom | April 18, 2009 at 09:48 PM
I disagree with Orman. We went from two incomes down to one, and we are able to pay more than the minimum on our debt. It's called being on a budget. I agree that you need to save some money as an emergency fund, but after that PAY OFF THOSE CREDIT CARDS!!! That is why Dave Ramsey's plan works. If it didn't, why is it that every Friday, many people call in saying that they are debt free, IN THE MIDDLE OF A RECESSION?
Posted by: Tim | April 18, 2009 at 10:14 PM
The sad fact is that if you have a load of CC debt during a recession and get laid off, then you're in deep do-do.
Your strategy should have been to live within your means and not accumulate CC debt while the 'good times' rolled on. At this stage of the economic cycle, you'd be better to focus on cutting expenses to the ABOSOLUTE minimum, so that you can pay off CC debt AND accumulate some savings, rather than just shifting from paying off CC debt to accumulating savings while keeping your expenses/living standard the same.
If Orman's strategy was sensible, then the logical conclusion would be to now put ALL your day to day expenses on your CC's until you had maxed them out, and use the surplus cash flow into an emergency fund. However, for the 90% of people who won't lose their jobs in the next year or two, having cash sitting in a savings account earning next-to-no interest, while paying off CC minimum amounts and paying 20% interest on the CC balance is a short cut to the poor-house.
Posted by: Enough Wealth | April 18, 2009 at 11:10 PM
Keeping an unsecured line of credit, with a variable rate on the books (i.e. credit card) is financial insanity if you have the cash to pay it off. Recession or not... don't worry about the "what ifs" of the future and pay off the known credit card debt. Probably 80% of our worries never even happen.
QUESTION: If you were debt free, would you borrow money on a credit card to have cash sitting in an "Emergency Fund" making 1-2%? No you wouldn't... unless you werebad at math or unable to think about risk.
Orman is wrong. Follow Ramsey's baby steps and enjoy true financial peace.
Debt = Risk
Posted by: Eric | April 19, 2009 at 03:07 PM
I tenatively agree with Suze's advice, but with a very important emphasis:
If someone does not have an emergency fund, it should always be their top priority!
However, as distasteful as it might sound, a credit card can also act as a secondary emergency fund. So, it doesn't hurt at all to pay off your card.
The very important context that I hope everyone will grasp is that, I'm not going to beat around the bush, if one does not have an emergency fund, they've not achieved even step 1 of their financial journey yet. Still, paying off a credit card that can double as a secondary emergency card can come in at a close second.
Yes, I'm splitting hairs.
Posted by: Eugene Krabs | April 20, 2009 at 09:15 AM
Thank you for the information, take a look at http://www.freemoneyfinance.com/2009/04/for-now-save-save-save-and-pay-off-credit-cards-later.html it was helpful to me
Thanks again!
Posted by: marilyn morado | July 29, 2010 at 11:03 AM
With so many people out of work and in trouble with credit cards.I'm shocked that more people aren't using credit counseling services. My cousin used one, and it actually really helped her.
Posted by: Mai | June 28, 2011 at 11:46 AM