Help a Reader: Credit Card Debt

Here's an email I recently received from a reader:

I am a senior in college and will be graduating in December. I have about $4,000 in credit card debt (I know) and about $1,200 in an ING Savngs account. I was wondering if you think I should keep that money in the savings account or start paying down my debt?

What advice do you have for her?

Comments

[Rod Ferguson]

Definately start paying down the debt. Chances are you're making 1-2% on the savings account and are paying 20% or more on the credit card; it'll end up costing you more by saving than by eliminating the debt. In the worst case scenario, you'll spend that $1200 paid to the CC by using the CC for essentials (can't pay your bills and have to dip into savings) so you'd end up saving for those months you didn't have to pay on the interest for that $1200 in debt.

To me, this is a no-brainer.

[My Life ROI]

Do you have a job lined up? I, personally, would be hesitant to take a big chunk of your savings and apply it to a credit card debt without the security of a job.

How awful would it be to pay off $1,000 in one swoop, not have a job, and then become at risk for being able to make minimum payments.

Do you have any more details for us?

MLR

[Ray]

To me both answers make a good point. Do you have a plan set up to pay down the debt? or are you just paying the minimum? if you have a monthly plan set up to reduce your debt and it's more than the minimum, than pay of the CC and reduce the amount you are paying monthly to CC and put some of it away in savings account. This will save you $ on interest.

[Cat804]

Pay the minimum payments until you get a job, especially in this economy. When you get a job put every penny toward the debt, but I would still try to keep that savings intact so you can still make payments if your job doesn't work out, and so that you don't have to go further into debt if a large unexpected expense comes up (car trouble, relocation expenses if you get a job in a new area, etc).

[Meg]

It totally depends on what kind of income you are going to have and what the rate is on the credit card.

If your credit is good, I would look to move the balance to a 0% card (they are still out there!) and don't pay it off right away. You might need that savings if you can't find a job or need to put down a deposit on an apartment or for any number of things during this transition period. If you can't get a 0% deal, at least contact the lender to see if they'll lower your rate to 10% or below.

If you're going to be making a decent income that you can live on, though, go ahead and take half the savings and put it towards the card, and then pay the rest off in chunks over the rest of the year (I'd leave at least $500 in savings no matter what).

But if you have no income lined up or aren't sure what your take home pay will be, just pay the minimums on the cards for now. You may need your savings for basic living expenses and/or job searching costs. Even if you're paying 15% or so, it's not that big of a deal in the short term on $4K of debt - better to have a small bit of security in the bank with some savings.

Whatever you do, quit using the cards if at all possible! You don't "need" a new couch or TV or anything else (with the possible exception of a decent suit, depending on your field) so fight the urge to use the cards for that kind of stuff "just this once." Trust me, the cycle will never end if you let it continue now.

[Mr. ToughMoneyLove]

Critical info is missing - what will this reader be doing with the credit card? More of the same?

Solve the spending problem first, then deal with this problem

[Bean Counter]

Under the assumption that the $1,200 is the total savings that she has, keep it in savings, pay the minimums until employment is secured, then start paying off the debt with your earmings. Yes, it's a better "investment" to pay off credit cards with a higher interest rate than the rate the savings account is paying, but there's something to be said for having a cash cushion, even if it's not the months of expenses that are suggested.

I also agree with Meg and TML, make sure the spending problem is fixed. Regardless of the option you choose, stop digging the hole. Good luck.

[Brad]

The critical piece of information is what are your options post-graduation. I graduated in the same boat with a large amount of credit card debt. I had the luxury though of moving back in with my parents and having a job, which allowed me to aggressively pay down the credit card debt. Really just depends on the scenario.

[Stephen]

As a recent graduate, keep the cash that you have while you're transitioning. I saved all of the cash I had after graduation and needed every penny of it while I was transitioning from college to a new city and job before I started having a regular income.

I don't see anything wrong with having some CC debt if you are graduating and moving from a low-cost (parents paying for, or loans paying for) school to a high-cost city, as long as you pay it off immediately once your income starts.

[Kira]

Get to a Dave Ramsey class. That is the single best thing you can do at your age to be smart about your money. Questions about this credit card are only the beginning.
If I could do it all over from when I got out of school, that's what I would do.

[Jason Fisher]

I think everyone has nailed various points. We don't have enough information to give a certain answer but general guide lines. I think you need to both keep your savings and begin to pay off your debt. If we assume this person has secured employment a small emergency fund is already in place and you can begin to use any extra money to pay off the CC.

However if, as has already been pointed out, there is still an underlying spending problem then that will need to be sorted out first.

[Dedicated]

Not enough information for a quality decision. You need to know:

1. Are you working now?
2. Do you have a job lined up for after grad?
3. Do you have transportation for that job?
4. Where are you going to live when you graduate?

At this point, if there is no job lined up or a decision for residence, it may be best to save and only make minimums on your debt. Then slam it after you become gainfully employed. These are tough times and nothing should be taken for granted.

[JimL]

I would leave your cash in an emergency account. Next, if you don't have a part-time job right now, you need to get one and eliminate this debt.

[Blaine Moore]

I pretty much agree, given the assumptions I'd keep the cash available and once you get a job pay it down as fast as possible.

Having a little credit card debt and making regular payments early in your credit profile isn't a bad thing.

If you do have some sort of income right now (part time or whatever) then you might want to apply a little more than the minimum payment, but only if it doesn't touch your savings.

Also, where did this $4000 come from? Don't spend any money that you don't have (especially once you have a regular income) and once you get this debt gone then pay off your balance every month. If the money isn't currently in a checking account, it shouldn't be spent on the card.

That's what worked for me post-college.

[Shaun]

Having a $1000 emergency fund is more important than paying off your debt at this stage. Just take your interest + any new income and make paying off your debt a priority.

Remember, if you don't have that $1000 savings account, then a sudden car problem or another emergency would instantly go to more credit card debt. Plus, in today's volatile economy, emergency funds have never been more important.

[kitty]

I am with Rob Ferguson here - why waste money on interest? The only exception are if you may not be able to minimum payments if you use this money. In this case you may want to hold off until you get a job. Also, if you can get 0% you may want to save money instead. Otherwise, I would advise paying off.

The total amount of money you have equal to savings - debt. To me it's not two buckets of money, it's just one. You have to think about maximizing the total, not keeping one bucket greater at the expense of the other. Every month you are paying only minimum payment while keeping money in your saving account, you are wasting money on interest. Even if you need the money a month from now and have to borrow again, you will have save a month worth of interest i.e. your total will be higher.

I would bet money that most people who have never been in credit card debt would chose to pay off high interest debt as soon as possible. Why? Because we think in terms of the bottom line, not mind tricks. Our ability to think in terms of the bottom line is what prevented us from getting into debt to begin with. Learn to concentrate on the bottom line, it'll help you in the long run.

"Having a little credit card debt and making regular payments early in your credit profile isn't a bad thing. "
Wrong - those who pay balances in full and never carry a balance have just as good if not better credit rating than those who carry balances. Ratio of balance to available credit is lower when you have smaller balance. Lower utilization ratio = better credit profile.

"Remember, if you don't have that $1000 savings account, then a sudden car problem or another emergency would instantly go to more credit card debt."
Yes, but by that time, he'll save a whole month worth of interest.

Here is an example. For simplicity, I'll ignore compounding as well as taxes on savings. You have $1000 debt at 12% a year or 1% a month. You have $1000 in savings earning taxable 2.4% a year. OK let's be generous and say you aren't paying taxes, so you are earning .2% a month.

a) you pay your debt now. You have 0 debt and 0 savings. One month from now you have an emergency that requires exactly $1000. You now again have $1000 debt with no savings.

b) you keep both debt and savings i.e. $1000 in debt and $1000 in savings. For simplicity I'll ignore the effect of the minimum payment for this month i.e. I will not subtract it from debt and savings as it is too small a factor to make a difference in interest. In a month you have a $1000 emergency. Isn't it great, you can use savings for it, so you pay it from savings. But during this same month your debt has grown from $1000 to $1010 while your saving grew from $1000 to $1000.2. So now you have 20 cents in savings and $1010 in debt.

How is being $1010 in debt with 20 cents in savings is better than being $1000 in debt with 0 in savings?

Yes, I used a simple case, but the idea is the same. Every month you aren't paying off your debt you are wasting money.

[Dee]

I am also a college student and if you don't have any pending student loans (you didn't mention that) maybe you should look at taking one out and paying off your credit card debt so that you can pay back the student loan at a lower interest rate. I've managed to just take out a $5,000 student loan and have zero cc debt. Hold on to the cash until you get some type of stable employment. Make the minimum payments.

[Sydrena Smith]

Hello Everyone. Yes I do work and I do pay the minimum now.

[Anitra]

I would still keep $1000 as an emergency fund. The rest, as long as you're working, can go towards your debt.

More importantly, after you graduate and get a better job (presumably) - keep living like a student for a while. You'll get that debt paid off and save up a nest egg in no time!

[AdamCO]

If you're working, you'll figure out a way to pay off the debt if you aren't accumulating more.

That's the single most important thing. Like someone else said, stop digging the hole. Learning to live on what you earn is far far more important than a strategy to pay off the debt.

[TME]

I found out the hard way that you can eat off of twenty dollars a month because I didn't have a cash cushion while I was job hunting. Unless you have a burning passion for hot dogs and ramen, it's not something I'd recommend.

Another thing to consider is health insurance. If your future job doesn't offer benefits, you'll need to self-insure. Even if it does, you might want to save that money to cover your deductable. Medical bills can cripple your finances if you're not prepared.