Sunday, April 19

Someone agrees with me!

Okay, obviously many of you readers have voiced your agreement with my opinions from time to time. And other times have even politely disagreed in ways that were thought-provoking and created an interesting dialogue.



But every so often it's just awesome to have a renowned personal finance writer write about many of the same ideas you've had/written about.



Enter Liz Pulliam Weston, aka the Web's #1 personal finance writer. She was once a coworker of my mom's up at the Anchorage Daily News, before she went back to school and became a PF writer.



Liz makes some statements in her latest piece The 0-Dollar Emergency Fund that pretty much coincide with some points I've made in previous posts.



She discusses the opportunity cost of saving for an emergency fund while you have credit card debt.


It makes no financial sense, for example, to have money sitting in a savings account earning 2% or 3% for years while you have credit card debt accumulating at double-digit rates. Paying down your credit cards not only lowers your interest costs, it also frees up space on your credit lines that you could use again in an emergency.



This is something I discussed in both Why I Won't Save an Emergency Fund and Emergency Fund Vs Debt -- the Eternal Debate.



Of course, I didn't have my arguments as prepared as Liz does. In the first article, I wrote about why it made no sense for Tim and I to save an EF while our credit card debt accrued so much interest. We, however, were speaking from a strangely secure position of financial difficulty. After all, Tim has no job to lose, and unemployment has been extended for the foreseeable future. I have disability payments and contract work that is pretty much assured through September, unless my performance utterly tanks.



Many of you wrote in asking how I proposed other people could pay bills. Truthfully, I hadn't thought the position through past my own situation. I was simply pointing out that there are times when traditional priorities such as an EF are actually detrimental to debt reduction.



Looking at the situation mathematically, it makes more sense to pay down credit card debt now. Then, if emergencies occur, you put them on the card. In the meantime, your balance is lower, thereby accruing less interest -- especially important given the popularity of the double-billing cycle.



But several of you wrote in to remind me that -- duh -- you have things like mortgages that can't go on a card (usually). So what to do? Well, Liz suggests a home equity line of credit. I'll wait for you to finish cringing.



We are all anti-debt. I know. The knee-jerk response is why anyone would want to take out a HELOC. Liz points out that the maintenance costs on such things are very low. The trick is to only use it if necessary, such as in an extended period of unemployment. This and credit cards will help many people stay afloat long after the traditional EF has run dry. Especially as unemployment averages stretch beyond all previous imaginings.



I have only one real fault with this idea: availability. Liz doesn't cover what to do if you're turned down for a HELOC. My guess would be to keep building your credit score up and re-apply. It's something you hope you'll never have to use anyway, so the only real goal is to apply before you need it. Still, credit is still tight, and we're waiting to see if the government's plans will actually get banks to loosen their stranglehold on lending funds.



To be clear, Liz doesn't seem to be saying you should ignore the EF altogether. She's simply reminding us that saving up for an EF may hinder your debt-reduction efforts. In addition, emergency funds may not keep you as safe as you had hoped. When you sit down and crunch the numbers, it makes more sense to throw the money at debt than into a bank.



I'm guessing a lot of people will try to repudiate this advice. Liz is finding cracks in a PF ivory tower. People love their emergency funds because it's soothing to have money in abeyance. It makes them feel less vulnerable, especially in such turbulent times. What's more, it's pretty hard on the ego to go further into debt. When you've worked so hard, for so long, to lower credit card balances, it's disheartening (to say the least!) to charge them up higher.


What do you think? (And feel free to agree with me -- apparently all the cool PF kids are doing it!)

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13 Comments:

Blogger Nadia said...

If paying down the debt opens that credit to be used later as a sort of EF then I see the logic. But on debt like student loans this doesn't apply, because there is no increasing credit when you pay that back.

April 19, 2009 at 2:16 PM

 
Blogger Abby said...

Nadia,

Excellent point. If you notice, she only talks about revolving credit. She makes the point in Deal with Your Debt. You should only pay down revolving debt, so that you still have access to the money.

April 19, 2009 at 2:41 PM

 
Blogger Fabulously Broke said...

Can I partly agree?

When I was clearing debt, my job was very secure and I saved $1k as an emergency fund because I had virtually NO bills to pay except for $600 in MINIMUM student loans each month. Period.

(I was living out of hotels on company dime, and I had parents in the area)

So I agree that in SOME circumstances, it makes sense. But to charge up credit card debt.. I mean, this is a risky thing she's proposing because what if you run out of credit?

What if you put 3 months worth of living on credit cards, and then are getting slammed with so much interest at 15% - 30% that it's just making it worse and worse??

It becomes a debt cycle that will be quite hard to dig out of. I watch these shows all the time on debt and how the interest just KILLS their paycheque and they can barely keep their heads above water even while paying bills and trying to clear debt.

It's a fine balance, PF...

And you're right -- what if people get turned down for loans? OR debt consolidation things?

I don't know. I guess I agree that that revolving debt and racking up debt on that would be a good move, but I cannot see the merit in getting more credit card debt.

April 19, 2009 at 4:25 PM

 
Blogger Alane said...

As someone who purchased a home in 2005 I can tell you that where I live I am lucky to be flat where it comes to what I owe and what the house is worth. No HELOC possible here. As for credit cards I have a BoA and they are raising my interest to a variable which is currently at 14.35%. I think this article may be a little old. Am I wrong?
I argree with her logic to a point but I would probably try to strike a balance between building an EF and paying off debt. I like the idea of having at least $500 to $1000 as an EF at least so when the little things pop up you can deal with them and would leave the cc's for bigger or longer lasting emergencies.

April 19, 2009 at 6:21 PM

 
Blogger Shevy said...

In general I agree with this idea, although it comes in for a fair bit of ridicule from the folks who just love their 6 month EFs. I do put money away for an EF, but only $12 per week ($48 to $60 per month, depending on the month).

I think the only real problem with paying down revolving credit with a view to using the freed-up credit in an emergency is the risk that the bank or credit card company might lower your limit or close the account.

That used to be very unlikely but it's happening to people every day right now, especially if they lose their job or miss a payment on a credit card or whatever. And it's happening to folks who aren't having problems too.

I actually had this happen to me with my IKEA card. I paid it off and they cut my limit in half! Gee, thanks.

April 19, 2009 at 6:33 PM

 
Blogger Meg said...

The problem is that in emergencies like many people are facing now, they DON'T have access to credit! My husband and I have GREAT credit scores, but even our credit lines have been decreased and I've had one account suddenly closed by the company after I paid it off. Bottom line, you CAN'T assume that you'll be able to just use credit.

Plus, if you suddenly lose your income -- which is when EFs are especially important -- how do you pay the minimums payments on your debt? It's not like the credit card companies are going to give you more credit when you start missing payments! Well... at least I hope they wouldn't.

April 19, 2009 at 8:35 PM

 
Blogger Donna said...

In other articles, Liz has written about why you need $500 in the bank and also that people who have some kind of EF sleep better and enjoy less stress.
Makes sense to me. You don't lie awake thinking, "What if the brakes go out? What if Susie breaks her glasses? How will we pay for this stuff?" You just hope that things will go well -- but if they don't, you've got a chunk of cash to throw at the problem, either paying for it outright or lessening the amount you have to put on a credit card.
Makes me sleepy just thinking about it. :-)

April 19, 2009 at 8:59 PM

 
Blogger Abby said...

Fabulously Broke,

I think what she's suggesting is to not save an emergency fund exclusively at the expense of credit card debt. A lot of PF advice hinges on the idea that the first move you make toward debt reduction is to save an EF.


And, obviously, putting everything on a credit card would be a worst-case scenario. As in: If your unemployment isn't enough to cover basic expenses or if you don't get unemployment and are simply trying to juggle funds while you find another job.


We have to remember that any time you would be dipping into an EF is a time when you're working with suboptimal conditions. Obviously, credit cards should be a last resort, as should borrowing against your house. Those are not good options. But they're better than losing your house.


Her point, I believe, is that many of us (as Shevy points out) can only save small dribs and drabs of income. So it will be years before our EF is funded completely. And 3-6 months' expenses may no longer be a viable amount to get you through.


Alane,

Apparently I misunderstood the person who sent me this link. It's from January 18th, or that's when it was last updated, at any rate. So some of this information is obviously in need of some tweaking.

Again, I don't think she was saying don't get an EF. I think she was saying, don't make it a priority to the exclusion of all other items.

Psychologically, though, sometimes an EF is above the price of gold and gems. Especially in tough times like this, I wonder how much a sense of security is worth.


Shevy,

I think you've found a good balance between EF and debt reduction. Though it probably seems frustratingly slow most of the time.

But you are right about the danger of getting your credit line cancelled/diminished.


Meg,

I'm sorry to hear about your credit situation.


I think you and Shevy are right that we should no longer assume the credit will be there, undiminished, forever.

But as far as the minimum payment thing goes... First, most people losing their jobs will receive some form of unemployment. This helps supplement bills, which lowers the amount you're putting on cards. It also provides soem money toward minimum payments each month.


Those who don't get unemployment will probably find some form of job -- probably low-paying int he extreme. That would allow them to make minimum payments while they search for a more sustainable salary.

April 20, 2009 at 12:42 AM

 
Blogger Meg said...

Nowadays I wouldn't even count on unemployment! Things are so backed up here that it took a friend of ours MONTHS to get hers! Meanwhile, she almost lost her apartment!

April 20, 2009 at 7:25 AM

 
Blogger Meg said...

Anyhow, no need to feel bad about our credit situation. We have a pretty good emergency fund. And if my husband's job wasn't as secure as it is right now, it would probably be even larger, but those are the sort of things you have to consider when figuring out how much money to put towards the EF or to debt. And right now our interest rates aren't too bad, so we're not losing a lot of money by having the EF. It'd be different if they were something outrageous like 24%.

April 20, 2009 at 7:29 AM

 
Blogger DogAteMyFinances said...

Wait, so what you really needed when Katrina hit was a credit card? Obviously, she wasn't trying to buy water or get an apartment (deposit and first/last month) in a new city. I have over 50K in credit card limits. Guess I'm ready for the next hurricane!

April 20, 2009 at 4:35 PM

 
Blogger Abby said...

Dog,

I don't think Liz is going for national disasters. More for people who become unemployed or otherwise encounter serious financial trouble.

April 20, 2009 at 7:32 PM

 
Blogger Revanche said...

I'm trying really hard to remember what the heck I did in college when I was paying for school and household, parents had just declared bankruptcy but didn't tell me, and BTed ~10k in CC debt for me to pay off.

Just out of high school, I was making pathetic money, and didn't have any kind of real savings other than money left over from senior year, but I definitely did save.

It was more along the lines of what Shevy's doing: any drip of "extra" money was salted away. Income was juggled day to day to meet each bill/pay down debt as quickly as possible. There wasn't any notion of saving "x months' worth for expenses" - the strategy was just "save for the emergencies that will come up, and try to hang on to as much as possible."

CCs were great once I figured out the rewards bit. Since I only used it for expenses, the rewards were my only source of "fun" income for years. They yielded a good enough amt of Borders GCs that I could treat myself and give gifts for a few years.

But I was only 20 years old and simple worked best for me.

So yes, I do mostly agree with you, Abby, in retrospect. Debt repayment came first insofar as the major income went, with savings a constant quiet companion.

April 21, 2009 at 4:12 PM

 

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