Personal Finance Tips

New Personal Finance Tips: Save up before Paying off Credit Cards

Until very recently, personal finance experts said that the most important thing you could do to avoid the debt trap is to pay off a high interest credit card. You can still find hundreds of tips and “golden rules” on how to cut credit card spending and reduce outstanding balances on several accounts at a time.

However, the advice given by personal finance expert Suze Orman on Oprah surprised the personal finance world, when she suggested that you should first save up for an emergency fund and only then pay down your credit cards, especially if you are at risk of losing your job.

Undoubtedly this is a major deviation from the advice generally given to cardholders. However, Suze Orman maintains that with the current recessionary environment and the rising unemployment rate, the urge to save money is a normal reaction. Primarily, her advice to create an emergency fund before paying down credit cards is intended for those who largely depend on job incomes and, perhaps surprisingly, those who have good credit rating.

Suze Orman explains her perspective as follows. First, if you do not have any other source of income besides your job, your first concern should be to build up some savings so that you have something to rely on if you become unemployed. Second, if you don’t want your credit score damaged, avoid having your card account closed. In order to keep it active, you should let its balance remain due while you are building up an emergency fund. However, remember that you should still make minimum payments in order to avoid negative effects on your credit report. Also note that if your card account remains inactive for 18 months, your card will be cancelled anyway, thereby lowering your available credit and hurting your FICO score. Therefore, it would be wise to make a small purchase every two or three months.

Once you’ve protected yourself with the emergency fund, start paying down your card right away. If you can, pay much more than the monthly minimum and do not make any new purchases with it.

As mentioned above, these personal finance tips are useful only for a certain category of consumers. As regards students that depend on their parents’ money, for example, their first priority should be to pay off and cancel any credit card that is too expensive for them to use. This is because a considerable part of credit history is built up at college, and the better you handle your payments there, the stronger the credit you will have upon graduation. Don’t be held back by the thought that your young credit will get a serious hit. The effects of closing a high interest rate card account are much less damaging than the consequences of the high interest rate, which may ultimately lead to a default.

In conclusion, your personal finance choices will depend on your own situation, so you needn’t follow these tips if you have a steady and reliable source of income that isn’t exposed to immediate danger at the moment. Nevertheless, most people tend to move towards securing their financial safety in a tough economic environment. So, you’ll need to decide for yourself whether it makes greater sense for you to build an emergency fund now or to pay off your high interest rate credit card balance first.

Doug Nicholas

Doug Nicholas, a financial consultant by profession with a Masters degree in International Business from Brown University, is also an ardent writer. Though he has a full time job at one of the companies listed on Wall Street, he does manage to squeeze in time to follow his passion. He puts his ideas to words in his articles related to finance and business.