At a time when unemployment has jumped from 5.5% a year ago to 9.4% in May, 2009 it's understandable that people are concerned about their jobs. source: Bureau of Labor Statistics
And their response has been predictable. The personal savings rate (personal savings as a percent of disposable personal income) was 5.7% in April, 2009. That's a 14 year high. source: Bureau of Economic Analysis
The same BEA report indicated that personal consumption expenditures (PCE) declined by 0.1%. In other words, many of us have shifted from spending money to saving money.
That's supported by statistics from the Federal Reserve. "Consumer credit decreased at an annual rate of 7-1/2 percent in April 2009."
So it would appear that much of the money that's not being spent is going to pay down credit card balances.
Under normal circumstances that would be the right thing to do. Pay down the most expensive debt first - i.e. the loan that charges the highest interest rate.
But, for many families these are not normal times. If you are concerned that your income could be cut or cut off, you might need to consider an alternative plan.
Let's look at a situation where your income is cut and is not sufficient to meet all of your bills. And, let's assume that you have a mortgage, one car loan and various credit card balances.
After a cut in income, the first thing you should do is to talk with anyone that you owe money to. Explain that your income has been cut and you need an adjustment to your payment schedule. Some companies will work with you. Others will not.
Next, you need to decide in what order you'll pay your bills. You already know that your income is not high enough to pay all the bills. So someone will not get paid.
Naturally, you'd want to pay the most important bills first. That would be your mortgage. Right behind it would be groceries to feed your family. A roof over your head and food in your tummy are pretty essential.
OK, now for the challenging part. The money that's left isn't enough to cover the car and credit card payments. What should you do?
What would happen if you fail to pay? If you don't pay your auto loan after a few months they'll repossess your ride. That could make job hunting more difficult. Not a pleasant thought.
On the other hand, if you don't pay your credit card bills you can apply for credit counseling. Typically they'll reduce your interest rate and lower your minimum monthly payment. The bad news is that your credit score will be negatively affected and you'll be expected to quit using the cards.
Not being able to use credit cards will be inconvenient. You'll need to use cash to buy groceries and other essential items. But, that can be done.
So logic tells us that it's wisest to pay your auto loan before your credit card bills. But, what does that have to do with today's extra savings at a time when you are able to meet all your obligations?
It may not be best to use that extra income to pay off the most expensive (i.e. credit card) debt today. The reason is simple. In a crisis you'd much rather have that extra money tucked in a savings account or CD so that it could be used to make mortgage and car payments later. The more money you have in savings the longer you can hang on with a reduced income.
There's a cost to this strategy. Instead of retiring 14% credit card debt, you'll be earning 1 or 2% on the savings. So it's fairly expensive insurance.
But, if you think that there's a good chance that you could see a significant cut in pay or lose your job, it might be something to consider until the danger passes. Remember that if you lose your job you won't get a 'do over'. Having some money in savings could be essential to your family's survival.
They say that extraordinary times call for extraordinary measures. This might be one of those times.
Keep on Stretching those Dollars!