Ben writes with an interesting predicament, and he hopes GRS readers can provide some guidance. He’s trying to dig out of debt and establish an emergency fund, but which is more important?
I recently accepted an offer for a 0%-for-12-months Citi credit card. (That’s 0% on both purchases and bank transfers.) I opted to get the money in a check, which I intend to disperse to my other cards in the debt snowball method.
However, it occurs to me that I only got in this current situation because I was out of work for a period of time and ran down my emergency fund. The job I have now pays the bills each month but leaves me very little left over to save. Cutting down on my credit card debt will help immensely, but my budget would still be skimming very close to the line.
My question is this: would you recommend the bank transfer at 0% be used for paying down debt, or should I take a portion of it (about half) and keep it in a savings account to restore my emergency fund?
I suspect the answer boils down to: do what works for you. Personally, I’d opt to put $1000 into savings, and then use the rest to pay off debt. Like Ben, I’m curious what others have experienced.
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December 28th, 2006 at 10:34 am
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.
December 28th, 2006 at 11:18 am
Use the 0% to pay off all of your debts on which you are paying interest. As long as you are in debt and being charged interest at credit card rates, it makes little sense to save money in a bank. Your credit cards have been your “emergency fund” in the past, and they can serve that purpose again in the future. To put it mathematically:
Chance that your credit cards will continue to charge interest for the next 12 months: 100%
Chance that you will need an emergency fund in the next 12 months: less than 100%
Pay off the credit cards. If you have an emergency again, they will still be there. The difference is the hundreds of dollars you will have saved in interest in the meantime.
To make it concrete: Say you have $10k from your new 0% loan and $15k in CC debt (assume 15% CC interest). You take that $10k and apply it to your CC debt. Net worth still is -$15k ($10k loan, $5k CC). Fast foward 4 months. The $5k on your CC has cost $255 in interest. You now have an emergency that costs $2k. You put that $2k on your credit card. Now your net worth is -$17,255 (original $15k + $2k emergency + $255 interest).
Now let’s look at the alternate scenario, putting that $10k into a savings account at 5%. Your $10k would be $10,167 after 4 months. Your $2k emergency comes up, which you pay out of your savings account. You now have $8,167 in the bank, but the $15k CC debt has accumulated an extra $764 in interest. Net worth = $8167-$15764=-$17596. You are worse off to the tune of $341, and that’s only 4 months of interest, assuming conservatively high interest on the savings and conservatively low interest on the CC debt.
You also need a plan to pay off the 0% loan in 12 months or less if possible.
December 28th, 2006 at 11:19 am
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.
December 28th, 2006 at 11:28 am
Have you also set a budget for yourself? Just the activity of writing down what you spend in the run of a month really opens up options on where you can save.
Also, you should look into getting a 2nd job if your primary income isn’t sufficient.
FT
http://www.MillionDollarJourney.com
December 28th, 2006 at 11:43 am
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.
December 28th, 2006 at 11:45 am
Build up an emergency fund first. You need a safety net while you’re paying off debt because “Life Happens”.
$1000 is a good recommended amount. Then pay off the debts, including this Citi card and build up a good sized emergency fund of about 6 months expenses. Get into the habit of saving up and paying cash for all purchases.
Remember, your emergency fund is for EMERGENCIES only. Its not for a PS3, school books, clothes or Christmas.
December 28th, 2006 at 11:50 am
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.
December 28th, 2006 at 12:04 pm
Are you talking about putting money on a credit account that you will have to pay back (at zero percent if paid within a year)? If that’s the case, I would not use any of that money. If you are cutting it close as it is, I wouldn’t take on thousands of more (potentially) free debt in the hope that I could pay it back before the 12 months is up.
Am I misreading the question?
December 28th, 2006 at 12:16 pm
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.
December 28th, 2006 at 12:41 pm
I’ll vote for eliminating the debt first. The fear of not having a sizable safety net will keep you motivated to pay the debt off quickly. This may sound a bit cold, but if you’re having a tough time staying on course, removing cushions often helps.
Think about what would truly get you in a bind, and make some provisons. For instance, go ahead and find a cheap mechanic in case you have car trouble. Prepare for anything that could keep you from working and paying the debt, and keep at it for a while!
Good luck paying off the debt! Glad to hear that you’ve got some options and things are looking positive
December 28th, 2006 at 12:50 pm
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.
December 28th, 2006 at 1:06 pm
For the emergency fund supporters… I am not sure I understand the rationale completely.
If an emergency comes up, why not just just use the free, 0% credit card to make the purchases?
The cash is earning 6% while the credit card is charging a rate that is (much?) higher. The worst case scenario is that the debt only gets paid down a little since there is an emergency that happens in the next year.
Then he’ll just have to roll the debt to another 0% card until he can pay that off. It looks as if the post’er is earning more than he spends. It is just a matter of time before the debt is paid off. The more of it that gets paid off, the more space he has to breathe. Maybe he can set aside some of the extra money he saves in INTEREST, and put it in the emergency fund.
A lump sum reduction in debt right now will save him hundreds or maybe thousands depending on the debt size, over the course of the debt period.
December 28th, 2006 at 1:18 pm
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.
December 28th, 2006 at 1:20 pm
Er…you realize that if you use the card to pay off the interest-bearing debts, you HAVEN’T actually paid them off, right? You’re just moving debt around.
I agree with Mike–I wouldn’t take it. Get a second job or cut your spending hard to get a $1000 emergency fund while paying the minimums, and then go crazy on the debt, knocking it out smallest to largest. (Check out Dave Ramsey’s snowball method for a more thorough explanation).
Only then would I build up a three to six month emergency fund.
I would also NOT keep the credit card. Obviously you are having a problem with credit in the first place–why would you get another card or line of credit? Cut up this card and close the account, and actually pay off the debt you already have instead of moving it around. I wouldn’t keep the card around even for emergencies, because if you have an emergency fund, you don’t NEED a credit card for emergencies.
December 28th, 2006 at 1:21 pm
HOWEVER — and this is important — I think that Ben should be working to establish an emergency fund in the meanwhile. A credit card is not an emergency fund.
December 28th, 2006 at 1:43 pm
I used to think having good credit to your name was your emergency fund. These days, I’m not so sure. I’d definitely build back some of the emergency fund and pay down the higher rate card at the same time if possible.
After the intro offer ends, I’d stop putting money into the emergency fund and pay down all the debt. Of course, I’m not taking my own advice here. It’s very hard to put it all into practice. But aggressive debt payoff really is best.
December 28th, 2006 at 1:45 pm
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.
December 28th, 2006 at 1:47 pm
funny I was just thinking about an emergency fund for us today.
For years we have not had one b/c on paper it makes more sense to pay down debt than to save b/c of interest. It isn’t working b/c as many commenters mentioned our credit cards became our emergency fund. We pay down and pay down and wham have to put a big charge on.
I wouldn’t use borrowed money for the fund though. For the last few months we have had $25 automatically taken out of our checking. It isn’t much but our budget is tight.When it is taken out automatically you don’t seem to miss it. We were also given a nice surprise sum at Christmas that will be going in the savings.
December 28th, 2006 at 2:30 pm
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!
December 28th, 2006 at 2:43 pm
Do both ! give a portion to your debt snowball and a little to your efund.
December 28th, 2006 at 2:47 pm
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.
December 28th, 2006 at 2:50 pm
a normal credit card is not an emergency fund - a 0% one is. i too would not create an emergency fund with borrowed money. i do think it’s safe to take a part of the 0% credit card (less than half)(a balance transfer is way safer than a cash advance) to pay down debts because 0% vs 13-20% is a no brainer.
but no way should you create an emergency fund with borrowed money. the long term rates are not in your favor.
if you really feel the need for the emergency fund, then take $50-100 from you paycheck monthly instead of using that $50-100 to pay down debt. that’s the smarter and safer way to go.
December 28th, 2006 at 3:12 pm
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.
December 28th, 2006 at 3:20 pm
I would also stick $1000 into an emergency fund and use the rest to go towards the other cc debt. Then I would work my tail off, including getting a second job doing something, anything, to get it all paid off this year. 1 year at 0% interest will get you very far in paying it off.
If an emergency comes up you have 2 choices. Use your EF or use the extra $ in your debt snowball to cover the emergency. If you use the EF though make sure that you replenish it to $1000 before continuing on with your snowball. Good luck! As you can probably tell I am a huge Dave Ramsey fan.
December 29th, 2006 at 12:42 am
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December 29th, 2006 at 7:49 am
Dear Ben:
I am curious about how much the interest will be in case you are not able to pay off your 0% loan in 12 months. If the interest is significant, and you aren’t completely sure you will be able to pay it all off in 12 months, don’t do it.
I would also make the case that hindsight is 20/20. Since you already recognize that not having an emergency fund got you into this mess, you know having one will prevent future messes. I recommend getting $1,000 built up as an emergency fund and cutting up all your cards, then paying them off with a snowball method. Dave Ramsey is right on with this. No one needs credit cards, for emergencies or otherwise. Having a card is not the same as having good credit. Don’t believe the hype. Best wishes in your efforts!
December 29th, 2006 at 8:26 am
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.
December 29th, 2006 at 1:43 pm
I’m in a similar situation. But have a few small questions:
1) If moving debt to a 0% card, is it better to apply for the card with all the balance transfers on the application?
2) What about minimum payments? Isn’t it likely you’ll be paying more per month on the new card?
December 29th, 2006 at 4:19 pm
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
January 9th, 2008 at 3:09 pm
I realize this is a very old discussion, but for anyone else in a similar situation, please consider debt consolidation instead of passing debt around from one credit card to another. To get these no-interest deals you have to open new accounts, which is bad for your credit and creates temptation to use your new credit whether you intend to or not.
Debt consolidation services can help you negotiate lower interest rates and lower total minimum payments. Of course you should pay as much as you can each month anyway, but having a lower minimum gives you some breathing room in that emergency everybody’s worried about, and makes it easier to build that emergency fund at the same time, if that’s what you decide to do.
Debt snowballs are well and good to a point, but when the debt reaches a certain point, consolidation can be a lifesaver.
February 10th, 2008 at 5:56 am
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”.
February 10th, 2008 at 7:19 am
I’m very curious how it all worked out for the original poster…did he find he was able to pay off that cc when the 12 months was up? Did the cc pull a bait and switch? Did he keep from adding additional debt to that new cc? And my biggest question…sometimes getting cash doesn’t count on the 0% for a year thing…only charges and transfers…How’d it go?
February 10th, 2008 at 7:41 am
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”.