Ask Liz Weston

Dear Liz: Help! In the last year, my credit scores have dropped 30 points. I don’t know why except that my credit reports noted that I used 10 credit cards recently. (I’ve had many dire emergencies lately, but I paid off all my balances as usual.) I’m terrified of more drops. What can I do?

Answer: Build up your emergency fund.

Because you charged your emergencies, you used up more of your available credit. The more of your credit you use, the more negatively your scores tend to react. It doesn’t matter that you paid your balances off each month. What counts is the balances that your credit card issuers report to the credit bureaus, which are typically the balances on your latest statements.

Now, the good news is that your scores probably will recover as soon as you start charging less. But you should take this as a sign that credit cards are a poor substitute for savings. An emergency fund could help you survive life’s inevitable setbacks without having to run to your cards.

Dear Liz: I have $16,000 in the bank as an emergency fund. I’m trying to get serious about paying off my debt, including a $7,500 credit card balance. I was thinking of getting a fixed-rate loan from my credit union to pay off the credit card balance in 36 months.

I have another loan (for my son’s private school tuition) with an original balance of $4,950. I’m supposed to make 12 payments interest-free, which will leave a balance of $3,020, which then reverts to 12.5% interest for the next 14 payments until it is paid off.

What should I do?

Answer: Getting a fixed-rate loan from a credit union to pay off credit card debt is often a good idea — if you don’t already have cash sitting around to pay off the debt, which you do.

Unless you’re in real danger of losing your job, using your savings to pay off the cards is a virtual no-brainer. Clinging to cash that’s earning less than 2% doesn’t make sense when your debt is probably costing you a double-digit interest rate.

When the card debt is paid off, you can focus on rebuilding your emergency fund — until the interest-free period on the school loan is up. At that point you should pay off the rest of the debt.

It should go without saying, but you also need to fix whatever issue caused you to rack up the debt in the first place.

If you can’t afford to pay in full when the bill comes, you shouldn’t buy it. That’s as true for private school tuition as it is for credit card purchases.

The fact that the personal savings rate is close to 7% is good news, but too many people are still unprepared for a major financial setback like a job loss.

A survey released yesterday by HSBC Bank USA found:

• 38% of respondents didn’t have even one month’s worth of expenses saved
• 61% could live on their savings for 3 months or less
• 51% of respondents with household incomes of less than $50,000 had less than one months’ expenses saved
• 29% of those who earned $100,000 or more had less than 3 months saved.

HSBC’s findings mesh with those of previous researchers who found only about one third of U.S. households had enough liquid savings to sustain them for three months or more.

Three months’ worth is a good goal in normal times, but in recessions, when the risk of job loss spikes, you may want more. The median duration of unemployment is now 14.7 weeks (nearly four months), up from a duration of 8.9 weeks (a little over two months) in July 2008. One third have been without a job for 27 weeks or more.

If you have toxic debt such as credit card debt or aren’t saving enough for retirement, taking care of those issues usually should take priority over building up your emergency fund. As soon as you’re able, though, stashing aside extra cash is a smart idea.

For more, read:

• Why you need $500 in the bank
• An emergency fund out of thin air
• When should you use your emergency fund?

Dear Liz: Do you recommend taking funds from a money market account to pay off high-interest credit cards? We are ages 57 and 60. One of us is retired and one is still employed.

Answer: The answer to this question is more complicated than you might think.

All things being equal, it makes sense to use cash in a low-interest money market account to pay off much higher-rate debt. But all things are rarely equal.

You may be taking a big risk if the money is all the cash you have in the world and paying the debt would wipe out this emergency fund. Card issuers are reducing credit card limits, so you might not be able to access your credit again in an emergency, such as a job loss.

If that’s the case, you may want to use only a portion of your cash to pay down the debt and pay the rest off out of your current income.