Ask the Readers: Emergency Fund or Debt Snowball?

You’re right, it basically comes down to what works for you. However, if I were in your situation, I would aggressively pay down the credit card debt with pretty much all of the balance transfer money.

This will save you money on interest charges. This saved money will make your budget less and less tight every month. Once you have paid off all the credit cards, then you can focus on getting the balance for your 0% credit card ready to be paid off.

I caution you with this method though… If you don’t think you can pay off the 0% balance very close to 12-15 months from now and the APR is higher than your current credit card debts, then I would progressively use more to put into the “emergency fund” to be used to pay off the 0% debt after the intro period.

I’m not sure I’m understanding this correctly. You got a check for the amount of your credit limit on a credit card?

If this is the case, you are essentially taking a 12 month loan that must be repaid within 12 months, right?

Now the question becomes, would you borrow money to use as an emergency fund? I think the answer here is clearly a no. Whatever interest you would earn would be negligible.

Pay off as much as you can on the credit cards. As William above mentions, this will cut your interest charges… which should give you breathing room in your budget. BUT, you must be careful! That breathing room is not to be wasted, because 12 months later you will owe again.

The idea to put a bit in savings ($1000) and use the rest on the debt is solid too. You just have to remember you are saving borrowed money that will come due within a year.

I would encourage the reader to go through a budget process — look at where all the money is going out. There are always way to save money. Have you cut your thermostat down in your residence? Have you canceled your cable/internet service? Have you completely cut out dining out? It’s possible to eat on a dollar or three per day.

Yes, drastic measures, but may be a look until you get your debts paid off and emergency fund built back up.

I agree with the advice of putting some portion (perhaps $1000) in savings and using the rest to start paying off cards.

And don’t start relaxing when you have your current cards paid off. Until you’re able to repay Citibank’s loan to you, you’re still in trouble in 12 months.

You need to examine your expenses and find other ways to cut until you get out of the hole.

I’m in a similar situation–I have a ton of student loan and credit card debt from my days in school. Now I’m trying to pay down my credit cards (my student loans are consolidated with a very low interest rate), but I’d also like to have an emergency fund, but I don’t think I can do both at once. Because I’ve racked up so much debt, I’ll be paying for quite a while before I’ll notice any let up on the budget. So I’m thinking I should just pay the minimums until I can get a small emergency fund set aside. I’ll feel great when I get all my debt paid down, but that will take years–in the meantime, I’d still feel better (even with the debt) if I knew I was not on the verge of disaster at the slightest unexpected expense. And I could set aside $1000 pretty easily in several months.

Emergency fund first! Here’s why:

1. The work required to establish the fund will be a deterrent to spending it frivolously. Credit cards do not have any work and so in turn have no deterrant.

2. An emergency fund is your buffer between Murphy’s law and sworn-off credit. To get out of credit, you have to stop using it.

3. It’s an easy success. This is encouraging.

I’d pay off all interest-bearing debt with your balance transfers. Then put half the funds that you were paying on the card minimums into an emergency fund untill you get to the afore mentioned $1000. I wouldn’t borrow against the new card for that, though. Use the other half of your prior payments to get a “jump” on the CitBank card.

Just because it’s %0 interest doesn’t mean it isn’t debt.

I’d scrape around for other sources of income or savings to supplement both efforts. As tempting as it is to pull cash out of the new 0% card, resist. (And it goes without saying, don’t charge anything on it or the old cards, either.)

I don’t have any cc debt and my true efund is good, but my short term accounts (taxes, deductibles, etc) are a little lean, as I raided them for some household repairs and the semi-annual property tax bite was deeper than budgeted. It IS tempting to consider that a ‘emergency’, but hopefully some belt tightening for the next three or four months will take care of it.

After reading the comments, I have to fully agree with William Wallets. Use the cards as a last resort emergency fund. Put it toward the debt, cut your expenses further, and continue to pay down the debt. Just don’t let that 12 month mark sneak up on you.

JD- hm.. If you can make interest on your emergency fund and borrow the money for 0%, why is that silly?

Of course, when the intro rate ends, he’d better have a way to pay off the money he put into the emergency fund… Which in that case, I do see your point.

Here’s my $0.02 —
* Use the 0% money to pay off as much of your interest-bearing CC debt as you can. Hopefully that helps to reduce your monthly payments

* Pay yourself first – skim 5-15% off the top of your check, and auto-transfer it away to an e-fund savings account. The psychology of this is amazing – if you never “see” it, your mind doesn’t think about spending it.

* Whatever is left on your check, use to pay your fixed expenses (rent/mortgage, utilities, etc), and then pay off your remaining credit cards, starting with the highest-rates first, and eventually working your way down to the 0% card.

My reasoning here is simple — build up your efund “behind the scenes” (with some kind of auto transfers), and use as much as you can every month to pay off your credit cards.

On the flip side of things — see what you can do about reducing expenses while you are paying off debt. Live without cable/internet for a while? Walk/bike instead of drive to save money on gas? Buy bulk groceries and/or fresh foods instead of packaged foods or eating out. Any extra money you save here will pay big dividends if you can pay off debt that’s costing you interest!

Take the best and worst case scenario of each situation…

1) If you pay off the credit cards and have an emergency, you can always add back to the credit cards – a situation that puts you no worse off than you are.

2) If you pay off the credit cards and don’t have an emergency, you make out way ahead – you’ll have a year of no credit card interest and that might get you completely out of it.

3) If you save it all for an emergency and don’t have one, then you are wasting money by having to pay the high interest from the credit card company.

4) If you save it all for an emergency and do have one, you are pretty much where you started, no gain on the credit card debt.

So in 1+2) (paying off the credit cards) you have a chance of coming out ahead – a good chance I’d say if you can avoid a true emergency.

And in case 3+4) if you save for an emergency, the best you can really hope for is to break even.

In my earlier post, I left out the $10k loan in my second calculation. The total was right, but the $10k was missing. It was also off by a dollar because I was rounding on paper while all the actual values stayed in my calculator. Should be

Net worth = $8167-$15764-$10000=-$17597.

Surely its true. Today, there are a whole lot of problems associated with bankruptcy, credit or debt settlements. We can only achieve a better credit-rating or gain a better score by becoming more acquainted about the entire credit system. I have come across a pretty simple article that explains the who debt consolidation or debt settlement process. http://www.debtconsolidationcare.com/steps.html is certainly very useful for your visitors too.

Similarly, it has become necessary to understand the overall distribution of the credit score. The following articles: http://www.myfico.com/Downloads/Brochures.aspx would certainly assist anyone who is interested to move up the credit rankings. You may cover this as a new post altogether. And keep up the good work!

Thanks to all for your insights!

Based on what I’m reading here, it looks like the consensus is for me to take the 0% loan and put it toward credit card debt (or, more accurately, shift the debt around). I’ll be slowly building the emergency fund using money that I earn, not borrow. I think Lazy Man and Money (#21) said it best: “If you save it all for an emergency and don’t have one, then you are wasting money by having to pay the high interest from the credit card company.”

One thing I didn’t mention in my original post that perhaps I should have is that while the CitiBank card is at 0% for 12 months, after that 12 months the interest rate is at least 8% lower than any of my other cards. So, unless they pull a bait-and-switch (like Chase did), in 12 months I’ll be better off even if I don’t do anything to reduce the debt. Of course, I will be working toward zero balances on all of my accounts during that time, so I expect to be much better off this time next year.

Also, in the time since I sent J.D. this question, I got a promotion at work(!) which will come with a salary increase that should further expedite my journey out of debt. (And before anyone says otherwise, let me say that any difference in monthly income will NOT go to luxury expenses! I’ve learned my lesson; it only took me 5-6 years of poor choices.)

Thanks again to everyone who commented! You all posted some great advice.

It may make things simpler to think of it this way:

You say that the new card will be 8% after the 12 months, so we’ll just work with that number for now.

Since 8% < 15%, it would be a no brainer to transfer all the debt from the higher card, to the lower card (and probably shuck the higher one in the shredder and get that thing canceled once its paid off… (if you have too many revolving credit lines it impacts your credit rating negativly, so don’t keep it around, because you’re not going to want to use it)

So, in the worst case scenerio, you go the 12 months and don’t pay off a penny of the debt, but you’ve (nearly) halved the interest payments you’re gonna have to make by shifting it to the new card. The 0% you pay for the 12 months is just icing on the cake.

It makes no sense to put money into savings when the interest you owe is greater then the interest you’d make in the investment. (like you’ve heard a dozen times here already, you can always use that credit card for your emergency fund if you have to). Emergency funds are only useful as a means of preventing the necessity borrowing money (once you’re debt free), and (in the case of something like a savings account) is there to draw on in the emergency (as opposed to, say, investments in mutual funds, or real estate) since the savings account is a liquid asset you can withdraw immediately, and for which you will be sure of its future value.

Randall

I thought you said you followed the principles of Dave Ramsey. What you’ve done is go into debt in order to fund your emergency fund and pay down your credit cards. You haven’t snowballed anything, just moved your debt around. Bad plan.
Don’t take the balance transfer offer – do the Baby Steps instead. #1: Put 1000 CASH in an emergency fund. #2: PAY OFF your debts using the Debt Snowball. #3: Finish building your emergency fund – not with some rip-off balance transfer offer but by SAVING UP YOUR CASH and putting it away.
Dave can get a little preachy sometimes but it’s hard to argue the wisdom of the Book of Proverbs, which he quotes a lot:”The rich rule over the poor and the borrower is servant to the lender”.

There is no way I’d take a 0% advance against a credit card and put it in savings as an “emergency fund”. Is that what we’re talking about here? What if you have an emergency before you pay off the advance and need to use the emergency fund for the emergency? Then you’re still stuck paying back the cash advance (or worse, possible stuck in a negative situation where you can’t pay off the cash advance).

On the other hand, I have used 0% balance transfers to help get seemingly out of control debt under control. It works, but you have to stay focused with pit-bull intensity for the duration of paying back the transfer, and it’s still a gamble. Of course, it’s a gamble you were making anyway by having the debt at a higher interest. You are still playing a game, but if you stay committed to paying it off within the timeframe of the 0% interest it can work out.

What I’ve done, successfully, is followed Dave Ramsey’s method, except that I’ve in the past transferred the balance of the debt I’m snowballing to a 0% interest card, and then knocked it out within 6-8 months instead of the alloted 12. It helped give me a psychological edge knowing that I was risking losing the 0% interest the longer I had it. However, I’ve only done that a few times and not in all instances where I’ve snowballed, and you have to weigh the transaction costs involved.

I’ve also taken advantage of offers for low fixed rate interest cards with no time limit for the balance transfer. (like 2-3% when they were at that level, lately it’s been 6-7% and it’s not worth it to me at that rate.) I moved a chunk of cc debt onto one of those offers around the same time as I moved a chunk onto 0% offers, just to escape the high interest rate trap while I was snowballing a different cc.

But again — you have to keep in mind that this can be a trap — you have to stay focused or its really easy to just tread water if not get right back into debt on another card, only to find you still have a huge chunk of debt lingering.

I know DR wouldn’t approve, but it DID give me traction on the debt to move it around like this. Other than this, I’ve very closely followed DR’s plan and it really does work.

I am not, however, fond of the debt consolidation companies. I think you have to read their fine print very carefully, and I’ve heard too many horror stories about people thinking their bills are getting paid only to find out their situation has become worse through mismanagement. I looked at utilizing the credit card company offers as my own, self-controlled exercise in “debt consolidation”.

If you lose your job, how long would you be able to keep your house and put food on the table? Will credit card bills be more important than say, keeping your house?
Why not make sure you can survive if you lose your job and takes you up to a year before you find a new job. I know somebody who is experienced and who was laid off 8 months ago and is now on the verge of losing her home. She has unpaid credit card debt, but her main issue now has become her home because she could lose it and she only has 6 years left to finish it. It would be a devastating loss to her, and that fear is closer than ever to becoming a reality. Where will she live if she loses it? Wouldn’t that be more important than credit card debt if the same happened to you?

I want peace of mind, and I am willing to sacrifice a lot to achieve that. I think the first priority is to have a short-term emergency fund because unexpected emergencies can happen more often. Perhaps you forgot to notice that you have to register your car this month, or some other unexpected expense. Or maybe you’ve received your annual life insurance bill today. That is the kind of thing that you can easily cover with your short-term emergency money and not have to touch those evil credit cards. Cover the short-term emergency with your short-term emergency fund, then pay it back as soon as possible. My short-term emergency fund is in a regular savings account. It’s $2,000 today, and it sits there on stand-by mode. (In fact, speaking of car registration, I believe I might have to register mine this month. I better check. No sweat, I have my trusted short-term emergency fund if needed. I do not use it very often at all, and I always pay it back as soon as I get paid.)

But one can’t survive on short-term emergency funds alone in today’s economy if one gets laid off. We are no longer in the 90′s, it takes the average American months to find a new job. For my long-term goals, I have what I call a hybrid personal finance model. I am simultaneously building a long-term emergency fund and paying down my mortgage principal. If everything goes well for me, and if I can continue on my current path, I should have a very sizeable long-term financial cushion (I am talking about at least a couple of years worth) and be mortgage free in 5 years. That is a possibility if I don’t lose my job and continue with my hybrid system. At the moment, I could spend a full year without earning a penny in income before having to deal with chaos.

I am middle class. There is no magic. The key to success is to be able to live way below my means. One needs to overcome instant gratification. Shopping has become a necessary evil, and not something used to provide my wife and I with recreation. I’ve been needing to buy new shoes for months now, but I always postpone it to next month. Hey, if I were a Bushman living in the desert, would I be able to buy new shoes this month? So it can wait a little longer. My current shoes are warn out, but they don’t have a hole yet. To feel good about myself, I don’t go shopping for stuff, I exercise several times a week and watch what I eat. For Christmas, both my wife and I agreed not to spend any money on ourselves. Instead, our Christmas gift to ourselves was sending an extra mortgage payment on Christmas day, which has put us one year ahead with our mortgage payments. But one year is still not enough in my opinion, and I expect to be able to survive 18 months without any income a year from now. If I get a bonus from my company this year, every penny will go towards achieving that long-term goal. No, I won’t buy new shoes with it.

I have successfully abstained from using credit cards for a few years now. I learned my lesson after having to deal with $8,000 in credit card debt. If we don’t have cash to buy something we need, then we have to live without. Credit cards are evil and we no longer use them. Relying on credit cards for emergency fund is something I can’t even think about. Relying on home equity for emergency can also be a fatal mistake. The big question is, does going into deeper debt sound like a wise way of surviving a long-term emergency situation?

As part of my long-term financial cushion, I have almost $10,000 in CDs where I can easily get to in case I lose my job. That money would not be used to pay my monthly mortgage because my next mortgage payment is due in 12 months. I need to make sure I can put food on the plate, pay utilities, etc, for a year if I lose my job.

I have completely stopped wasting money trading cars. I now buy a car that is in great condition and drive it to the ground. Two years ago, when I decided to change my life, I had 3 auto loans. I paid them off and decided that having car payments was a major barrier. It became painful. I couldn’t be paying my mortgage down and ahead of schedule simultaneously if I had to spend hundreds on car payments every month. I was like most people, I made up excuses to trade my car for something else. Trading in an almost new Honda Civic for a brand-new Camry was an example of a bad financial move in my part. The excitement of driving that new car vanished as soon as the first payment was due. I came up with an excuse to buy a new car though. I told myself that the Camry was a larger car, even though we didn’t need the extra room at that time. And trading the almost new Camry for a huge Sienna was even a worse decision. We certainly did not need the extra room, which came at a steep price as the gas consumption went way up and so did the payments. And buying a motorcycle was also a mistake. And so I ended up with 3 auto loans, no emergency money and 1 paycheck away from chaos. Two of the cars I traded in were leases, so I was ripped off big time when I decided to return them early. Those were financial mistakes. But I am proud to say that I have learned from my mistakes. What I spent on monthly car payments is now used towards building my long-term financial cushion.

Here’s how I am paying my mortgage ahead of schedule, which is a major part of my long-term financial cushion, and down so I can finish it in 5 years if everything goes well.
I alternate between making an extra, separate payment, and paying more towards the principal. On month 1 (this month because we are in January of 2010 as I write this), I will be making two separate mortgage payments, one for each paycheck that I will be getting this month. The first payment will be paying my mortgage for January of 2011 (a year from now), and the second payment is to pay the mortgage payment for February of 2011. I get on my mortgage company’s website, click on a link after logging in and in seconds I have submitted a mortgage payment to pay my next statement. On month 2 (that will be February), I will be making a single mortgage payment at the end of the month. The second payment on month 1 will be double the size, with 50% being entirely used to pay down my principal so I can pay off my mortgage in 5 years.

For my short-term emergency fund, I have $2,000 in my savings account. I can use it for simple emergencies if needed without having to touch my long-term emergency fund. I have used it now and then to cover unexpected expenses, but nothing major.

Up until last year, the thought of losing my job was something so terrifying that I did not allow myself to think about it. I thought that suicide could be one way that my wife and children could keep the house if I lost my job. That is no way to live. I should expect the best, be prepared for the worst. Today, if I get laid off, I won’t be happy, but I will go home peacefully knowing that I have a full year before collapsing. To me, financial independence is having peace of mind and not living from paycheck to paycheck. My goal is a two-year financial cushion.

Building a VERY DECENT emergency fund should be a religion.

while i see this is an old post people are still commenting, so i’ll add my 2 cents. Let me understand this. You took on MORE debt (albeit 0% for 12 months) so you can pay DOWN (not OFF) your c/c’s (you said using snowball method, that infers to me that you’re not just paying them off) and people think this is a good idea?

No matter how you look at it, unless you took that money you borrowed at 0% and immediately paid off all your other c/c’s in total, and now are faced with only paying off the 0% balance card, and have a definite plan to do this in 12 months, you just incurred MORE credit card debt.

If I’m not understanding you correctly, my apologies, then just take the interest you were paying on the old debt and put that in savings while you pay off the new c/c debt at 0% interest. you’ll still be saving and paying down your debt at the same time.

while i’m a huge fan of the emergency fund becuz of its ability to wean you off credit cards, it doesn’t sound like you’re committed to not using credit cards, so you might as well reduce your debt as best and fast as you can.