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, last month 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 in the past year.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.
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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. One banking analyst has predicted that card issuers will cut total limits by more than half in the coming months.
- Talk back: What do you think of Orman's advice?
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, recently echoed her advice. And Wall Street Journal columnist Brett Arends went even further. He recently 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, you're 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.
Video on MSN Money
How to save for an emergencyExperts say you need 3 to 6 months' worth of your total expenses in an emergency fund. The question is, how do you put away that much?
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.
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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.
Continued: When Orman is right
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