Recently, famous finance guru Suze Orman, who usually doles out sensible advice even if in an disrespectful manner, has advised the public to stop paying off credit card debt any faster than minimum payments allow in order to shore up a savings account that could last eight months in an income emergency. According to this recent advice, the economy has changed in such a way that interest payments on debt are small prices to pay for the disaster of a personal recession.
It’s fair to say that Orman has a valid point for some. For example, this advice should be directed to a person whose income depends on a job from which he or she might be soon laid off, if that job is in an industry in which it will be difficult to find a new job, and if he or she won’t settle for a lesser job in while searching for a full replacement. But that describes only a small sample of the population. Orman is painting the picture with too broad a brush.
Liz Pulliam Weston recently pointed out this disagreement with Suze Orman. Weston points out that paying only the minimum to credit cards identifies you as a risky customer. Risky customers are punished by credit card issuers with increased rates and lowered credit limits, in some cases, without advance notice. Besides the direct effect of less available credit and higher interest payments, these actions have an unfortunate downstream effect. It is likely that this will result in a lower credit score.
Again unfortunately, much of modern society relies on a credit score. Your credit is checked when you apply for a loan or mortgage. But it is also checked when insurance companies determine your rates. Auto insurers have found that low credit scores, or credit risk in general, correlates to a risk of dangerous driving. Therefore the insurers feel justified in charging customers with lower credit scores higher premiums for the same coverage. Some employers check credit reports and scores to determine whether hiring you may present an undue risk to the company. And landlords check credit reports and scores when deciding whether you are fit to lease an apartment.
It’s very difficult to function in modern society without a credit history, and a good credit score and clean report goes a long way to make sure you can operate and navigate through life smoothly. Suze Orman’s advice might put that at risk in exchange for an oversize emergency fund in an environment in which the interest you can earn on savings is very low. It could take years to build up eight months’ worth of expenses in cash reserves, and paying only the minimum towards credit cards during that time will prolong and increase the cost of debt. If the minimum payments don’t even cover the amount of new interest charged, by following Suze Orman’s advice, you would be condemning yourself to a life controlled by debt and the credit card companies.
Suze Orman’s advice might be sensible for some people, but it’s important to think about the consequences of all but abandoning the elimination of debt. Where do you stand on Suze Orman’s advice to forgo debt repayment in favor of an eight-month emergency fund?
Published or updated April 27, 2009.