Pay off credit cards vs. emergency fund vs. 401k match or some combination

[jtraggie99]

So I currently have about 37K in credit card debt (this after a number of years of poor decisions and a recent divorce), I have no emergency fund, and I am not contributing to my employer matched 401K.  The CC's are all currently at 0% interest, but those rates will begin expiring throughout next year, at which point I will try to shuffle things around to keep rates as low as I can.  I currently pay about $1400 over the minimum's for each on a monthly basis, and anything else additionally that I get goes toward it (work bonuses, etc.). 

My immediate goal is to pay that off as quickly as possible, then contribute the minimum to my 401k to get the full match, then emergency fund, and so on and so forth.  I know I'm passing up free money by not taking the company match right now (current salary is $89,100 and they match 100% up to 6%), but I detest having the debt and I'm concerned about not being able to maintain low interest rates until it's paid off.  And of course, not having the emergency fund is worrisome.  I feel like I've taking some recent big steps to try to move in the right direction.  For example, I have two kids that live with me 50% of the time, and we moved into a 2-bedroom apartment over the summer, and my 6 year old son and I are sharing a room.  This is not supposed to be long-term, maybe a couple years, until I get on better financial footing. 

Anyway, I know there is a ton more information I could provide, but I go back and forth a lot on the best ways to proceed and just wanted some kind of reassurances that I am taking steps in the right direction to finally getting my financial life together.

[Jags4186]

Contribute the 6% to the 401k.  Keep 2 or 3k in a checking account.  Throw everything else at the debt.  Cut the cards up and move to debit/cash.

[Runrooster]

Financially the thing to realize is that the 401k is pretax, so if you're in a 35% bracket, you're only going to drop $300/month, not the full $450.  Also, keep in mind that most employers do the match on a pay period basis, so that if you pay off your credit cards in August you can't make up for missing eight months of the year.  Not sure what else to say, I think it's important to establish the habit of saving in both 401k and emergency fund.  I understand the concern about 0% rates changing, but I would put cash in an emergency fund until each of them comes due. Especially with kids and a divorce, stuff happens.  Maybe start with 450 pretax into 401k and 500 post tax into savings, somewhere invisible so you have no urge to spend it.

[Retired To Win]

So I currently have about 37K in credit card debt (this after a number of years of poor decisions and a recent divorce), I have no emergency fund, and I am not contributing to my employer matched 401K.  The CC's are all currently at 0% interest, but those rates will begin expiring throughout next year, at which point I will try to shuffle things around to keep rates as low as I can.  I currently pay about $1400 over the minimum's for each on a monthly basis, and anything else additionally that I get goes toward it (work bonuses, etc.). 

My immediate goal is to pay that off as quickly as possible, then contribute the minimum to my 401k to get the full match, then emergency fund, and so on and so forth... Anyway, I know there is a ton more information I could provide, but I go back and forth a lot on the best ways to proceed and just wanted some kind of reassurances that I am taking steps in the right direction to finally getting my financial life together.

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

And you are willing to have one of those events slam you and not have a cash reserve on hand to weather it?  Not me; no way, Jose.  The emergency reserve fund needs to come FIRST, with minimum payments on the debt until that emergency reserve has been built up.

IMHO, of course.

Good luck.

[Malum Prohibitum]

. . . 37K in credit card debt . . . I have no emergency fund, and I am not contributing to my employer matched 401K.  The CC's are all currently at 0% interest, but those rates will begin expiring throughout next year, at which point I will try to shuffle things around to keep rates as low as I can.  I currently pay about $1400 over the minimum's for each on a monthly basis, and anything else additionally that I get goes toward it (work bonuses, etc.). 

My immediate goal is to pay that off as quickly as possible, then contribute the minimum to my 401k to get the full match, then emergency fund, and so on and so forth.  I know I'm passing up free money by not taking the company match right now (current salary is $89,100 and they match 100% up to 6%) . . .  not having the emergency fund is worrisome. . . .

My two cents.  Stop paying the $1400 each month plus anything else additionally (work bonuses, etc.) on the credit cards.  They are 0%.  Put that money into savings each month.  Then at least you have a choice around the time that the cards start running interest.

You are stressing out because you have no emergency savings.  So make some.

With no money set aside, when an "emergency" does happen, you will use credit cards, which is not going to help your debt situation.  Build up some savings.

Also, contribute the 6% and get the 100% match.  I do not know what the credit cards are going to go up to next year, but I bet it is not 100% plus the tax savings from putting money in the 401(k).

[halfshellmeijin]

I would pay down the CC first, the 401k match, then emergency fund. I don't know what you are spending per month, but if an emergency comes up you can charge it. Worst comes to worst you are in the same spot you started or the emergency will be so bad you would resort to charging again anyways. I would consider getting the match in the 401k first as in the long run you will end with more money. It depends on your situation and what you are comfortable with.

[Goldielocks]

Contribute the 6% to the 401k.  Keep 2 or 3k in a checking account.  Throw everything else at the debt.  Cut the cards up and move to debit/cash.

This!!!

I would get the buffer in the chequing account first, then get 401 k match, then debt.

There is no better time to secure a basic future retirement. 

[cube.37]

Out of curiosity, if someone were very debt averse and wanted to prioritize crushing debt first, is there a reason why he/she couldn't invest in the 401k up to the match, then withdraw the entire amount every year (or every month) to pay down credit cards? For example, in this case, could jtraggie99 put in $5346 this year ("current salary is $89,100 and they match 100% up to 6%"), then receive a match for $5346 and withdraw it all? There would be a penalty of 10%, and regular federal and state tax (lets say 30% total), which would turn out to be $6735. This is greater than the $3742 he would have received without the match-withdrawal process.

Obviously this only would work in a 0 vesting period match.

Looking for any legal issues with this approach, or something that I might have misunderstood which make this impossible.

[zephyr911]

Ouch! Been there, done that! The good news is, you're gonna be okay.

I agree with a minimum of 6% to the 401k. Between 100% match and tax savings, you're earning well over 100% instant return on that money.

I would strongly suggest you not only work out a monthly budget, but also forecast your debt paydowns to figure out how long it will take you to kill each card, in order of 0% promo expiration, to minimize total cost.

In terms of emergency fund vs. debt paydowns: unless there are potential emergency expenses that you can't use a card for, it makes more sense to zero out your checking account on the paydowns every time you get paid (minus whatever fudge factor you feel compelled to use). IOW, as long as the funds are retrievable, there's no benefit to holding them in checking.

The last time I was in a credit card payoff situation, I literally paid every cent to the card except for what I had budgeted for automatic payments. With free overdraft protection and the card itself as my emergency fund, there was no point in holding anything. My checking balance was often exactly $0, so the card balance was always as low as possible. I paid what I could, I spent what I needed, and eventually there came a day when the paycheck was bigger than the statement balance, and the interest stopped. Victory!

[zephyr911]

Out of curiosity, if someone were very debt averse and wanted to prioritize crushing debt first, is there a reason why he/she couldn't invest in the 401k up to the match, then withdraw the entire amount every year (or every month) to pay down credit cards? For example, in this case, could jtraggie99 put in $5346 this year ("current salary is $89,100 and they match 100% up to 6%"), then receive a match for $5346 and withdraw it all? There would be a penalty of 10%, and regular federal and state tax (lets say 30% total), which would turn out to be $6735. This is greater than the $3742 he would have received without the match-withdrawal process.

Obviously this only would work in a 0 vesting period match.

Looking for any legal issues with this approach, or something that I might have misunderstood which make this impossible.

It's not illegal, but unless he plans on taking many years to pay off this debt, he'll save more money by leaving the 401k alone.

If he's in the 25% bracket, which is likely, he'll lose 35% even before state taxes, meaning he withdraws $153.85 for every $100 in debt repayments. Even if we assume an insane APR of 25%, he could drag his feet for 45 months paying off this debt, and still pay less in interest than the equivalent taxes and penalties on that 401k withdrawal.

See attached screenshot where I worked this out in Excel.

That's not even accounting for the temporary 0% promotional rates, which allow him to pay it down faster before interest starts working against him. Nor does it include the option of transferring the cards again to get new 0% rates after paying 2-3% in transfer fees, or rolling them over into another form of financing with a lower rate. In summary, there are way better options than pulling from that Stash right as he's starting to build it.

[AnEDO]

+1 for 401k match.  There is also the fact that every paycheck that goes by that you are not contributing the 6%, you are losing about $50 to taxes and $200 in employer match (assuming 25% marginal tax bracket and 26 paychecks/year).  So for a reduction of about $154 per paycheck, your 401k balance will go up about $400 each paycheck (your contribution + tax savings + employer contribution).

[zephyr911]

With no money set aside, when an "emergency" does happen, you will use credit cards, which is not going to help your debt situation.  Build up some savings.

Scenario 1: pay $1000 toward credit card, experience emergency, charge $1000 on credit card. Save ($1k x APR x time elapsed).
Scenario 2: hold $1000 in checking, pay interest on the $1K for no reason during the elapsed time, pay cash for emergency.

NW @ time of emergency payment in Scenario 2 is lower than Scenario 1 by $1k x APR x time elapsed; what is corresponding benefit?

[Rubic]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

[JLee]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

Except it's not certain, because he's running 0% promos right now.

[zephyr911]

Even at 0%, there's no identified advantage to holding cash vs. paying debt (equal @ zero effect on NW).

As soon as 0% ends, he will be paying interest on the lesser of 1) the amount of his e-fund, or 2) the amount of the balance subject to interest, without reason.

[Reynolds531]

Plenty of good advice above so just a couple of thoughts:

Do the 401k - don't leave free money on the table.
You WILL be Ok. It's only 37K, a lot of people come from divorce with a lot worse. So be grateful. Just tackle it methodically and never carry a balance again when you get clear.

[Malum Prohibitum]

Even at 0%, there's no identified advantage to holding cash vs. paying debt (equal @ zero effect on NW).

As soon as 0% ends, he will be paying interest on the lesser of 1) the amount of his e-fund, or 2) the amount of the balance subject to interest, without reason.

  The benefit is sleeping better at night.  He said the lack of any cash for emergencies is stressing him out.  Telling him to rack up more debt on the credit card in an emergency just is not going to let him sleep better at night.

[Malum Prohibitum]

Out of curiosity, if someone were very debt averse and wanted to prioritize crushing debt first, is there a reason why he/she couldn't invest in the 401k up to the match, then withdraw the entire amount every year (or every month) to pay down credit cards? For example, in this case, could jtraggie99 put in $5346 this year ("current salary is $89,100 and they match 100% up to 6%"), then receive a match for $5346 and withdraw it all? There would be a penalty of 10%, and regular federal and state tax (lets say 30% total), which would turn out to be $6735. This is greater than the $3742 he would have received without the match-withdrawal process.

Obviously this only would work in a 0 vesting period match.

Looking for any legal issues with this approach, or something that I might have misunderstood which make this impossible.

It's not illegal, but unless he plans on taking many years to pay off this debt, he'll save more money by leaving the 401k alone.

If he's in the 25% bracket, which is likely, he'll lose 35% even before state taxes, meaning he withdraws $153.85 for every $100 in debt repayments. Even if we assume an insane APR of 25%, he could drag his feet for 45 months paying off this debt, and still pay less in interest than the equivalent taxes and penalties on that 401k withdrawal.

See attached screenshot where I worked this out in Excel.

That's not even accounting for the temporary 0% promotional rates, which allow him to pay it down faster before interest starts working against him. Nor does it include the option of transferring the cards again to get new 0% rates after paying 2-3% in transfer fees, or rolling them over into another form of financing with a lower rate. In summary, there are way better options than pulling from that Stash right as he's starting to build it.

Wow, excellent post.  I wish there was some way on this forum to "rep" you for it.  You put a lot of work into that answer.

[Runrooster]

I think that paying credit card vs holding emergency fund is splitting hairs right now, and basically amounts to which one helps him sleep better.  My vote towards some emergency fund is partly based on the assumption that new credit card charges will not be at 0%  He may or may not be able to do an immediate rollover into a 0% rate, but if he already has one, why give it away?  Another point is that the 401k can act as that catastrophic emergency fund - arent some penalties waived if he's in hardship?  In my case there was a possibility to do a loan against the 401k at a low interest rate.  Certainly if he's laid off, paying taxes on a distribution are the least of his issues. 

Zephyr, the hole in your analysis is that taxes will come for his 401k whenever he withdraws it.  He might move into a lower tax bracket if he waits until retirement, but if he experiences a long layoff that might be the same effect.

[Rubic]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

Except it's not certain, because he's running 0% promos right now.

OP is currently paying $1400 over the minimums on $37K of CC debt.  At that payment schedule it will take him over 2 years to pay off the credit cards, which will be much higher than the 0% promo rate.

[JLee]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

Except it's not certain, because he's running 0% promos right now.

OP is currently paying $1400 over the minimums on $37K of CC debt.  At that payment schedule it will take him over 2 years to pay off the credit cards, which will be much higher than the 0% promo rate.

Unless he transfers to another 0% card.

[Retired To Win]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

If/when an emergency should hit, there's no guarantee that the credit line will still be available.  You've got to have some cash set aside in an emergency reserve.

[RangerOne]

I'll agree that holding the cash until the debt repayment starts taking interest is the safest move. I've seen at least a few people fall into despair because they dumped all their money into loans leaving themselves no cash only have the same monthly payments and no back cash when times got hard.

Normally I would say cap out your emergency fund and dump the excess into loans, but you can hold off on making the decision for a little while.

[norabird]

I don't see any reason that you can't continue transferring the balances to other 0% cards as your promo rates expire. Put in the 6% (free money! plus it starts compounding, stocks were 'on sale' earlier this year, lower taxes), and keep throwing extra on whichever cards promo rate expires first. The emergency may or may arise, but the credit card debt is already there, so deal with that first. Note this quote from a recent WSJ article (http://www.wsj.com/articles/the-hidden-reasons-people-spend-too-much-1446433200) addressing the preference of savings in cash even when they aren';t advatageous:

To test her idea, Ms. Sussman and a co-author conducted online surveys. In one, she recruited 185 people to answer questions about how they would pay for a $1,000 emergency expense. They were asked whether they would spend money from savings or use a credit card at 10 different interest rates, from 0% to 30%.

In a forthcoming study in the Journal of Marketing Research, Ms. Sussman found that even though people were theoretically earning 1% interest from their savings, they were willing to borrow money at much higher rates to keep their savings at a certain level.

“I’m not at all saying people shouldn’t save,” says Ms. Sussman. “But even people with an appropriate liquidity cushion want to keep more money in their savings accounts because it makes them feel responsible, even though it might lead them to do these behaviors that are potentially economically costly.”

Savings are not always the most important thing (though tax advantaged matches are!)

[Rubic]

There's just no way that I can go along with putting the emergency fund behind the debt paying and the 401K contributions.  The operative word here is EMERGENCY.  Which is a sudden and seriously BAD thing that happens to you when you are not expecting it.  Like getting laid off.  Like having the house burn down.  Think of very, very bad things and THAT is what emergencies are all about.

If OP starts paying down his 37K in CC debt, his credit limit can be considered a short-term substitute for an emergency fund.  Not ideal, but he's probably much better off than paying a certain 15-24% interest on CC debt rather than a possible emergency contingency.

If/when an emergency should hit, there's no guarantee that the credit line will still be available.  You've got to have some cash set aside in an emergency reserve.

In 35 years of using credit cards, I've never had a credit line shut down or a credit limit lowered unless I requested it.  If OP has a current utilization of $37K, short of money laundering he's unlikely to get cut off.

Multiply two low-probability events together (emergency %1) x (credit shutdown %1) and OP has a 99.99% success rate.  (You can choose alternative values, but the point remains.)

I'll concede (and should have stated) that OP can hold cash and defer paying the credit cards until the %0 bonus rate expires.

[K-ice]

You are getting so many different answers your head must be spinning.

Most of it is good advice, but people just have different philosophies.

To project your debt payoff here is a great spread sheet:

http://www.vertex42.com/Calculators/debt-reduction-calculator.html

You will need to redo it as the CC start charging interest but for now it is great that they are all zero.

I would keep a small "emergency" fund.  I keep the minimum in my checking account, so I pay no fees with a balance of $1500. If you don't have fees I would still keep $1000 to sleep better at night with that little one snuggled beside you :) 

Then contribute to the 401K to get a match.  But I would only contribute 2% just to get into the habit. Your hair is on fire with debt!

Then of course hit the CCs hard.  How you pick may depend on the date they start charging interest or how much interest they will actually charge.

For example
Card 1 8% in 4 months
Card 2 22% in 6 months

I would pay off card 2 more aggressively even though the interest kicks in a bit later.

With that spread sheet you can play around and pay them off:
Snowball (lowest balance first) Psychologically some people like just getting rid of a card completely.
Avalanche (Highest interest first)  you could plug in the projected worst case scenario interest
Custom (number based on first interest due date) that card may even be zero before the interst comes due :)

Best of luck!

[BBub]

Just MAKE A PLAN.  At this point, the exact order is kind trivial. 

Sure, you could fully optimize the situation by getting the full 6% match on 401k, saving cash until your CC's fall off the 0% grace period, then snowballing the $37k debt down - all while keeping $1k savings on hand a la Dave Ramsey. 

But don't worrying about the exact position of the rearview mirror while parked on a train track with a freight train barrelling towards you. 

Make a plan, stick to the plan, dig out of debt. 

Then LBYM, save lots every month, invest, repeat.

[robartsd]

My plan would be

• be sure to always be ready to make minimum payments
• get the 401k match
• hold as much as I can in the highest rate savings account I can get while 0% promo rates apply
• four or five months before 0% rate expires, assess current credit score for chance of getting a new 0% promo rate - use savings to pay down credit cards only if I think it will make the difference in being approved for the target card
• two or three months before 0% rate expires, apply for the new promo card and balance transfer
• in last statment cycle before 0% rate expires, pay as much remaining balance as possible (hopefully getting to 0 before interest applies)

I would NOT keep an emergency fund beyond one month's minimum payments (for all contractual obligations) at any point while paying credit card interest.

[jtraggie99]

Thanks for all the responses everyone.  I really appreciate it.  So, the 401k match makes sense and seems like a no-brainer at this point.  Also, just for peace of mind, I think having a little cash on hand will help, I'm thinking 1,000.  From there I am going to pay everything additional on the credit cards.  Yes, once the 0% promos expire, I will try to transfer things again, but there is no guarantee I will be able to maintain the low rates.

I think that's a good starting point and way to move forward. 

[Malum Prohibitum]

I am going to pay everything additional on the credit cards.

  I would just pick one card and then pay everything additional on it, while paying the minimum on the others.  Which card I pick would depend upon the balance (how soon could I knock it out?), the interest rate that will go into effect (what is this going to cost me if I do not pay it off in time?), and when the interest rate goes into effect (can I beat this card down to $0 owed before the interest kicks in?).

[Rubic]

Yes, once the 0% promos expire, I will try to transfer things again, but there is no guarantee I will be able to maintain the low rates.

Be aware when you apply for additional credit the banks will be looking at your credit utilization, the amount of credit you are using compared to your credit limit.  Utilization in the 0-10% range is best.  Above 30% will adversely affect your credit score, and thus your ability to roll over your debt to another card.  Also some banks only care about the aggregate utilization, while others consider utilization on individual cards.

[jtraggie99]

I am going to pay everything additional on the credit cards.

  I would just pick one card and then pay everything additional on it, while paying the minimum on the others.  Which card I pick would depend upon the balance (how soon could I knock it out?), the interest rate that will go into effect (what is this going to cost me if I do not pay it off in time?), and when the interest rate goes into effect (can I beat this card down to $0 owed before the interest kicks in?).

Yes, that is exactly what I do.  I pay it all on one card, pay that one off, then move onto the next.  The order depends on the balance and when the interest rate could go up.

[jtraggie99]

Yes, once the 0% promos expire, I will try to transfer things again, but there is no guarantee I will be able to maintain the low rates.

Be aware when you apply for additional credit the banks will be looking at your credit utilization, the amount of credit you are using compared to your credit limit.  Utilization in the 0-10% range is best.  Above 30% will adversely affect your credit score, and thus your ability to roll over your debt to another card.  Also some banks only care about the aggregate utilization, while others consider utilization on individual cards.

Thanks, but yes I am aware of that.  That said, I would like to avoid opening new cards as much as possible.  I have a couple right now that are paid off with pretty decent credit limits.  I have kept them open for this very reason.  At least one of them has offered me a 0% balance transfer recently, I am just hoping that will still be available when I need it.  I've also found that banks will often offer low transfer rates if you call them up asking to close the account (once it's paid off).