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?