Fund Emergency Savings or Pay off Debt?
My goal is to have $1,000 in my emergency fund. However, I'm not sure of what I should focus on first. We currently have around $50k in debt (mostly student loans) and we are really sticking to our budget to pay off as much debt as possible in the next couple years. Should we forget about our emergency fund and use that money towards debt?
Well, what happens if you have an emergency? Will you have to take on more debt to pay for it? It would be credit card debt most likely which I'm guessing has a higher interest rate than your student loans. I personally would pay the minimums on debt until I could save up a minimal emergency fund of $1,000 and then return to debt paydown.
However, to be clear, I am coming from a personal disposition of not being bothered by the existence of student loans and mortgage debt. I only pay about $15 extra per month on my mortgage and the only reason I do that is so it can be a round number. When I had student loans, I didn't pay extra on them until I paid a lump sum to clear the debt. And the only reason I did that is because I had 3 years where I had basically no living expenses so I though I may as well take that chunk I've saved up and pay off the loan. Otherwise, I would have plodded along for the next 10 years paying the minimum. YMMV.Reply
Student loans are an unsecured, usually low-interest, installment debt. Each of those things is a reason to make them lower priority than other types of financial security. I would clear any secured debt (car loans) and any revolving debt (credit cards) relatively quickly, but I wouldn't even begin to pay extra on the student loans until I had a substantial emergency fund, far beyond $1,000. And I would definitely build up a small emergency fund before even starting to clear the revolving debt.
There are people who fancy themselves financial gurus (ahem DR) who advise that all debt is equal and you have to get it gone ASAP. But the fact of the matter is, if you have an emergency, as @jenmas points out, and you don't have the money for it because it has all gone to the student loans, you have no way of accessing that money. Your only option will be to take it back out on some sort of higher-interest loan. Mathematically, that is crazypants.Reply
The only debt that I would consider liquidating an emergency fund would be credit card debt, because in the case of an emergency you'd just draw from the credit card and would not be worse off than when you started.
If you pay off any other type of debt by eliminating an emergency fund that you cannot redraw, you'd have to draw from a credit card at a high rate to pay for the emergency, which would only make things worse.Reply
In debt-pay-down mode I established my initial emergency fund at $1,500, which was about half my monthly income, and after a couple of scares, I slowed down my debt-payments to minimums while I got a month ahead (leaving all this month's income in the bank account untouched to budget next month). Admittedly, this is a very conservative approach, especially if you have high-interest debt and you feel the constant pressure of interest accruing. But, in my situation, I needed to take into consideration that I had also closed all credit accounts. Knowing I had no access to credit of any kind, it soon became obvious that I needed to keep some cash liquidity and timing flexibility in my own hands.Reply
Second the opinion of throwing emergency fund money toward high-interest CC debt. (There's not too many emergencies you can't handle by swiping your card if it came to that.) The main reason you even have that "emergency" money now is that you didn't send it to the CC when you should have in the past.
Accelerate low-interest student loan payoff after rebuilding an acceptable cash emergency fund again.Reply