In Suze Orman‘s most recent book, “2009 Action Plan,” she urges people with credit card debt to pay off their balances as quickly as possible using the high interest first method. “The fact that you pay just the minimum is a huge warning signal to your credit card company,” she writes, “that you may already be on shaky ground.” Now she’s changed her mind and says you should just pay the monthly minimum and put the rest of your money toward building an emergency cash stash. Based on the way credit card companies have been behaving, we think she has a point.
Originally, Orman’s goal was maintaining a high FICO score by having paid-off credit cards on your account. This served a second purpose, too: your active, paid-off cards provided a source of quick cash in case of a huge life emergency.
Now that credit card companies are slashing credit limits and unexpectedly closing accounts on customers—even ones with stellar payment histories and low debt-to-credit-limit ratios—Orman says all bets are off.
So here is the problem. If you do not have a stash of cash in an emergency fund and you have been using all your extra money to pay down your credit card debt and they keep closing your cards down-what are you going to live on if you lose your job? Chances are you may not have any available credit, or too little credit, to use in the event you are laid off. Nor will you be able to get a new card if you are unemployed.
So what’s the right size for an emergency account? Orman says 8 months of living expenses, and even if it takes you a couple of years to build that up, this is no time to trust that your credit cards will be there for you in the months to come. Once you’ve hit that magic number, go back to clearing off those credit cards.
What do you think is the right amount of an emergency savings to build up, especially if you remove the safety net of open lines of credit from the picture?
“A Change in Credit Card Strategy” [SuzeOrman.com] (Thanks to Greg!)