Updated: 9/22/2010 9:00 AM ET|
Bad advice from Suze Orman
Pay just the minimum on your credit cards? For most people, this shocker from influential media personality Orman is a lousy idea.
Credit card debt is a cancer that eats away at your finances, costing you a fortune in finance charges and leaving you vulnerable to issuers that can raise your rates or lower your credit limits at will.
So why is Suze Orman telling you to stop paying down this debt?
Orman, the author of multiple personal-finance best-sellers and host of a popular CNBC show, has advised her fans who don't have "fully funded" emergency accounts to start paying only the minimums on their credit card debts and instead route any extra money into savings:
"If you have an unpaid credit card balance and not much saved up in emergency savings I need you to listen up. My advice has changed.
"I want you to only pay the minimum due on your credit card balance and instead make it your top priority to build as much of an emergency cash fund as you can."
The bold directive makes for a great sound bite. I just wish it were good advice.
Right now, paying just your minimums is exactly the kind of behavior that will attract unwanted attention from the credit card issuers Orman is warning you about.
Yes, there's a credit shortage
Let me say first that I think Suze Orman usually gives good advice, and she certainly has a point this time: The credit climate has dramatically changed since 2008.
Until recently, paying down your revolving accounts -- credit cards and lines of credit -- was considered a win-win: You saved on interest, and you freed up credit that could be used again in an emergency.
But these days, lenders are cutting off access to credit just when people are likely to need it most. Bankers are freezing or lowering limits on credit cards and home equity lines of credit or closing accounts altogether.
Meanwhile, few families have enough savings to get through even a short stretch of unemployment. Hence Orman's advice to hoard cash. She's not the only one encouraging that strategy. Debt expert Steve Rhode, the founder of GetOutOfDebt.org, has echoed her advice. And Wall Street Journal columnist Brett Arends went even further. He has suggested borrowing against credit cards and using the cash to boost your emergency fund, writing that for those who don' t have sufficient savings, "some of the normal rules no longer apply."
Why this strategy can backfire
There are plenty of problems with these kinds of one-size-fits-all, bridge-burning approaches, however. They assume the worst will happen, when it probably won't. And they don't distinguish between families on the ragged edge and those that are merely worried.
Meanwhile, those who take the advice are paying significant costs.
It can take years for many families to accumulate the eight-month stash of cash that Orman advises people to have for emergencies. If you abandon your debt repayment plans until you have that much saved up, you could:
- Pay unnecessary interest.
- Risk damage to your credit scores.
- Make yourself even more vulnerable to lenders' whims.
The biggest problem with paying only the minimum these days is that it brands you as a high-risk customer, much like someone who maxes out his or her cards. Lenders, desperate to reduce their risks, are more likely to yank back credit lines or raise rates on any customer they consider at higher risk of default.
If that happens, there can be a domino effect. Lower credit limits can hurt your credit scores, because any balance you have looms larger in the scoring formulas. Lower scores can lead other lenders to consider you high-risk, increasing the chances they'll change your rates and terms or make future credit harder to get.
And now, more than ever, you should protect your credit scores. People with mediocre or poor scores are missing out on some of the best interest rates on loans since the 1950s, and they pay more for insurance as well, because most insurers use credit information to determine premiums.
Good scores, by contrast, get you better deals on loans as well as the power to fight back against rate increases and lower limits.
When Orman is right
There are circumstances where paying the minimum or, preferably, just a bit more is the best of bad options. That's true if:
- You've been or are about to be laid off. In general, you want to hoard cash when you lose your job. You should cut expenses, look for other sources of income and delay debt repayment plans until you're back on your feet.
- You're on the financial brink. If you're living paycheck to paycheck, you have no savings and a layoff would send you over the edge, then paying minimums may be appropriate. Look for expenses you can cut and funnel the extra cash into savings. If you're in really deep, consider talking to a bankruptcy attorney.
- Your accounts have already been frozen. If you won't be freeing up additional credit by paying down your debt, putting that cash into savings might be the better option, especially if it's relatively low-rate debt.
If your situation isn't so dire, however, a more balanced approach might be the best course. That means:
- Staying the course. Continue paying down credit card debt, but look for extra expenses to cut to pad your emergency fund as well.
- Opening an escape hatch. If all your credit cards are with the same issuer, consider getting a card or two from different issuers so all your credit isn't in the hands of one lender.
- Monitoring your accounts. Many lenders are trimming credit lines with little notice, so checking your credit limits at least once a month is good practice.
- Pushing back. Card issuers are hoping you accept their changes without a fuss, but if you have good credit scores (FICOs of 720 or above), you have some leverage and should be able to get them to rescind their decisions or take your business elsewhere.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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The reason why a lot of CC users have maxed out cards is they do not have any emergency back up funds to work with, so they use their cards for fixing cars, taking an emergency trip, ie., which in some cases will max them out.
Everyone should have the cash available to pay for emergencies and only use the card or other credit when they can pay the balance each month. If they don't have emergency funds, they shouldn't purchase anything with a card. They should live without until they can afford to pay for it directly.
If they have gotten into bad debt and do not have the savings, I agree they need to build up the savings anyway they can, even if it means paying minimum on the cards. A good Credit Union will have programs to help people with their credit card debts and most will make the person requesting help have an emergency fund. To do that, they will work with the Credit card companies to set up a schedule of payments and put some away in an account along with setting up a good budget.
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