Should I Use Savings to Pay Off Credit Card Debt?

Eric writes in with the following question about using savings to pay off credit cards:

I have about $2,000 on a credit card and I have about $5,000 saved for an emergency fund. Would you recommend taking out the two grand out of savings and paying off the card? I know that is probably a dumb question, but maybe I just need reassurance from a third party.

I should add that I own my own business and this year has started off worse than last year, so that is why I am a bit more nervous about taking it out of the savings. Also, what goes on the card are usually business expenses that really need to be bought. Kind of a difficult situation, and I think that I will just have to figure out how to not put anything on the card, and figure out how to lower my overhead in my business.

Eric, in just two paragraphs you’ve summed up a predicament many business owners find themselves in. Using your credit card to cover business expenses is not necessarily a bad thing, as long as revenues can cover those expenses, and allow you to pay off the card in full each month.

When your business credit card balance begins to grow, I start getting nervous because it is a very slippery slope to finding yourself deep in debt. It sounds like you are already looking for ways to reduce your expenses, and that is definitely a great first step.

In this scenario, I would not use savings to pay off the credit card, because it would wipe out 40% of your emergency fund. Instead, I would drastically reduce business expenses and use all business earnings over the next few months to eliminate your credit card balance. You may pay a little more interest, but preserving your emergency fund should be a priority in tough times.

In the mean time, I would consider moving to a cash-basis for purchasing supplies – even if you had to set aside $1,000 or so from your emergency fund as a buffer in your business checking account. Once the credit card is paid off, continue to keep expenses low and build up a business emergency fund representing six months of business expenses. Keep this money separate from your personal emergency fund (which should represent 6 months of personal/household expenses). Think of it as your own business line of credit for lean times.

With your business emergency fund in place, and your credit card debt paid off, you’ll be in a much better position to resume investing in your business again. If you decide to resume making purchases with your credit card, be sure to pay off the balance in full, and stop using it immediately if revenues drop off and you are unable to pay the card balance.

I hope things improve and you are able to hang on to your business. As an entrepreneur myself, I am well aware of the passion and energy business owners pour into their endeavor. Sometimes that dedication blinds us to the fact our business isn’t doing too hot, and we look for creative ways to keep it funded (such as turning to credit cards, home equity and small business loans). I admire you for tackling your debt before it became a big problem, and I suspect you can clean this up rather quickly and move on to enjoy future success.

Ask the Reader: What additional advice do you have for Eric? Do you agree or disagree with the advice I gave?

Comments

  1. I agree 95%, the only area where I do not agree is that using credit to fund business is a good idea. Can’t go along with that since I’m a dyed-in-the-wool, never-use-debt-again Dave Ramsey addict. Ok, so I’ve laid my cards on the table. I too run a business of sorts, though some might qualify it more as an investment. I own and manage rental properties. Before I knew Dave I did what most people did: took out mortgages to buy property and put all my materials on a Home Depot or Lowes card (hey, I got a 10% discount). Since then (about 2.5 years ago), I’ve sworn off debt in personal and business life. Some might think it foolish or impossible, but really once you’ve made the commitment to no more debt it’s amazing how creative you can be. I found that I can still get my 10% discount (I’m military National Guard, Lowe’s always does 10% off…nice! For those non-military, you can get 10% off coupons on line or at the post office…no credit card required), and I’ve found ways to ensure my monthly expenses are met through rents. I was a little nervous at first, but as grandma used to say “the proof is in the pudding.” I’ve weathered the worst economic crisis since the Great Depression and today am thriving where some many other debt-ridden landlords are upside down with bills coming out their ears.
    So do as FD suggests: keep your emergency fund intact and get those expenses down. Pay off that card, then CUT IT UP! People don’t get wealthy using credit cards, but they do sometimes go broke. You’ll never miss the frequent flyer miles.

  2. As a business owner, I’d disagree. The CC debt may just be disguising the fact that the business isn’t currently viable. I would – and AM – using savings to cover lean times. At what point would one stop putting debt on the CC and start using the savings? You say not at $2K. What then? At $3K? At $5K? At $10K? At $20K? It’s all well and good to hope things turn around, but if they don’t, then you are left in a hole with a lot of CC debt.

    But yeah, I totally agree that you need a float account for the business with retained earnings to cover slow times. That’s essential.

  3. In my particular situation, yes I use the funds to pay off the credit card. Heck, if worse comes to worst, you can always use the credit cards (or another loan instrument) to take out a cash advance and be in the same situation…

    But that’s me, you need to do what you think is best in your situation :)

  4. I would pay off the debt. Yes – your savings will be low, maybe too low IF something happens. And IF something happens that costs more than your emergency fund, just put it on the card and you are no worse off than you are now. But if no emergency happens, you are debt free and can continue building the fund.

  5. Samantha, answer this question: If you had no savings and your credit card was canceled, what would you do if you lost your income? That answer will tell you what you need to do.

    Experts (and again I site Dave Ramsey as well as many others) recommend an emergency fund of 3 – 6 months living expenses. If you’ve got more than that socked away, then use the surplus on your credit card debt. Otherwise, “cash is king.”

  6. I would not touch the Credit Card debt unless the interest was high >12%.

    These days the credit card companies are reducing limits. What if you paid the CC to zero and the CC company slashed your limit by $1000 to a $1000 limit. You will be in a worse situation.

    $5000 is not a lot money as an emergency fund that would six months 6 months of your expenses. What if you have a rental unit go vacant or two rental units go vacant?

    Loans are scarce and limits are being reduce on CC accounts so be careful how you do it so you don’t box yourself in.

  7. @Chris Curran. My credit card limit has never been lowered. Not now. Not ever. Probably because I never run it up. And if one runs it up it can always be lowered to just above what you have charged anyhow. The idea that one should run it up because otherwise one might not have it is the kind of scare tactic that leads one to make bad decisions.

    And I would posit that if anyone is in the Real Estate business with no cushion of a 3-6 month e-fund, they are in the wrong business completely.

  8. I would say he should definitely not use the whole $2,000. If he does feel the need for some sort of change, he could always use $1,000. Yes, it’s still depleting his emergency fund by 20%, but the psychological difference between $2,000 of debt and $1,000 can be huge. So that would be one alternative to take.

  9. I would not use the savings. Further, I would make sure my business has the credit card. If you have to go under- it should be business and not your personal savings that takes a hit. Not exactly a popular stand- but one my father taught us long ago. (He never went under).

  10. @Diane raised an great point. If you cannot pay off the the running debt now at what point do you pay? As you suggested yes it is a good idea to have a business card as long as the balance is paid off every month. Otherwise there are issues with cashflow in the business.

  11. I’d pay it off now. Think about it this way. You pay off the debt, and you have $2000 more credit available to your name, but $2000 less in your bank account. All you have done is transferred a portion of your emergency funds from Cash Via Savings account to Cash Via Credit card.

    In the meantime you are not accumulating interest. And if you never have an emergency, you just have out ahead big time.

  12. I understand the reasoning behind the advice, but I am the type of person who would pay of the debt.

    The reasoning is, if it turns out you didn’t need the emergency money – you just saved yourself a little interest.

    If you do end up needing the money, you can always tap into the credit card if needed.

  13. “In my particular situation, yes I use the funds to pay off the credit card. Heck, if worse comes to worst, you can always use the credit cards (or another loan instrument) to take out a cash advance and be in the same situation…

    But that’s me, you need to do what you think is best in your situation” – Money Reasons.

    I’m totally agree with Money Reasons.

  14. @Diane

    “My credit card limit has never been lowered. Not now. Not ever.”

    Just because it hasn’t happened to you doesn’t mean it doesn’t happen and it won’t happen to you no matter how you have used credit. I guess you have been reading about a lot of people like yourself have your limit reduced.

    “And if one runs it up it can always be lowered to just above what you have charged anyhow.”

    Which is my point. If you lower your balance and they lower your limit you will have less available cash because you paid down your CC. The interest paid on that debt is insurance against running out of liquidity while the emergency fund is too low.

    “The idea that one should run it up because otherwise one might not have it is the kind of scare tactic that leads one to make bad decisions. ”

    I NEVER indicated that he should run it up. Why would you imply that I would give that ridicules advice based on my post.

    I stand by my advice until he can have a larger emergency fund. As a property owner/manager he may have sudden vacancies or emergency repairs. $5000 is pretty low in that juggling act.

  15. I give completely different advice. I always advise paying off the credit card debt with saving. It’s not reducing your emergency fund it’s just saving you interest. If you can get more interest in saving than you can on credit card then fine if you can’t put ALL of your saving credit card

  16. @Chris Curran: Using your credit card doesn’t give you more “cash” – it gives you more debt, and debt with interest that you pay every month. It is costing you money to park the savings and not use it. That may be a psychological game people like to play so they feel secure, but financially it’s a losing game. I cannot really understand why anyone would run up a CC balance if they had cash at hand to pay for things. A credit limit is completely fungible. It means nothing. It’s certainly not an expression of how much “cash” you have.

  17. I agree with most of the advice, but…

    Suppose the limit on the CC is $2k and it’s maxed out, and you have $5k emergency funds in the bank. The total amount you have ready to for an emergency is $5k.

    Now suppose you pay $2k to the CC. You still have $5k available for an emergency: $2k on the CC, and $3k in savings, but now you’re not paying the high interest rate on the card.

    At the point you pay the card, you need to consider the card for emergencies only!

    This only works if you make an effort to reduce expenses, use cash flow rather than credit for the business, etc. If you pay it off, then fall back into your old habits, your worse off b/c you’ll end up w/ $2k of business expenses on the card, and just $3k in the bank.

  18. @Diane

    If they cut his CC limit from $2000 to $1000 then his available money in an emergency is reduced by $1000. He will have $4000 in the bank and the credit card maxed at $1000 (in this scenario) which reduces his available money from $5000 to $4000.

    It’s debt but if one of his tenants moved out or water heater failed he might need that extra available $1000.

    He of course needs to judge his own situation but don’t be so quick to insist he pay off debt and box himself in. It might end up costing more in the end. Emergency Fund first!!! and everyone’s particular dollar amount for an emergency fund is different for each of us. $5000 as emergency fund seems low to run rental property but I have no idea what is expenses are for his part of the country. It may be enough or it may be way too small.

    I put over one thousand dollars a week into savings and then transfer to invest accounts from there. I have zero debt, BUT when I was trying to obtain this financial position I paid off one debt (auto loan) too quickly thinking I would save ~$40 interest and ended up having to borrow money because I came up short one week and ended up paying more then ~$80 by the time the smoke cleared. I wasted a lot of time and embarrassment (personal loan). Been there, done that and won’t go back.

  19. Wonderful advice. Insufficient emergency/reserve funds is the #1 problem I see with clients, especially those that own small businesses. Credit remains tight, especially so for businesses right now. While you should make some effort to accelerate your debt repayment, an ample reserve fund can literally be the difference between life and death for your business if you don’t have alternative sources of liquidity.

    One other option is to try to build up trade credit with your vendors on a formal or informal basis. If you can find more credit with your primary vendors, you may be able shift some of your financing needs from your credit cards to them, often at a 0% interest rate!

  20. I’m sorry Frugal Dad but that isn’t very good advice you gave. Don’t pay off the credit card so his “emergency fund” is larger? That is EXACTLY what a credit card is great for – emergency funds!

    This talk about not using credit cards is completely foolish. Learn how to use your credit card responsibly. It’s FREE credit every month, you don’t pay a single cent in interest! You’d be a fool not to use your credit card. The only time you should pay cash is if you can get a discount versus a CC. Every possible expense you have should be put on your credit card, why not use the bank’s money whenever possible? At the end of every month pay off your card in full.

    A few people mentioned that there is the possibility of credit limits being reduced. If you are one of those people who consistently pay off their credit card in full every month the banks are in love with you. They may be cutting credit back for mediocre borrowers but they are increasing limits for their top customers! They need to make their profits some where and the banks are focusing on low risk debt. This is a great time to get more credit for those who deserve it.

    If you have issues with overspending or following a budget, that is a completely different conversation and the above advice should be completely ignored.

  21. @ Bill

    Sorry, Bill, but banks don’t “Love” people who pay off their debt every month. Nothing could be farther from the truth of the industry. In the Credit Card/Banking industry people who pay off their balance every month are called “deadbeats” because banks can’t capitalize on card users who don’t carry a balance. They make most of their money off those who carry a balance, those who don’t have very good credit scores and for those they can charge penalties and fees. The more responsible you are the less profit they can make off of you and business is always about profit margins.

    You are mistaken, Credit limits have been reduced on people with good credit and no history of problems. The Internet is full of stories in the past 18 months of people having their interest rates raised for no apparent reason. Why? Because banks are desperate for money and THEY CAN. Credit card contracts can be changed by the bank after you have signed the contract to pretty much whatever they want. They have to warn you of the change but the typeface on those contracts is intentionally small and full of legal-eze.

    I suggest having credit cards but use them extremely carefully. If you can’t control yourself with a credit line then you shouldn’t have a credit card; it’s for your own protection.

  22. If payment for credit card balance is affecting cash flow, pay it off completely. However, if you can swing the balance, pay it off once the economy is more stable. In the meantime do NOT use the credit card! His ultimate problem is the RECESSION which is why he has a balance. Cash is King right now.

    HIs decison is about how much RISK he is willing to take: Debt vs. Cash. There is no “right” or “wrong”. That’s LIFE.

  23. Sounds like the business might need a separate line of credit.

    If you are using a personal credit card, then I would rush to pay off the debt as the business is part of one’s personal finances.

    If you are buying things as part of a business, then I would establish a second line of credit for the business. After which there should be a clean break between personal finances and business.

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