Ask the Readers: Savings or Debt?

May 23, 2010 13 Comments

I have been working towards building my Emergency Fund to my target of $5,000 while also trying to pay off my Student Loans.  This approach is restricting my ability to accomplish either very effectively since my money is being divided between both.

I have given this situation a lot of consideration over the past year or so and had settled on trying to pay down my debt while also building my Emergency Fund, though now I am beginning to think this may no longer be the best choice.

The high interest portion of my Student Loan balance (I have a total of $32,157.96) that I want to pay off within the next year lingers at $14,417.68 with a 6.8% interest rate, which translates into $980.40 a year ($81.70 a month) in interest charges.  I am paying $350 a month towards this debt.  I am eligible for grants and have earned a small scholarship which I hope to be able to use towards paying down some of my Student Loan debt.

My Emergency Fund balance is $1,907.03 and will cover 2.5 months of living expenses.  The interest rate on this account is 1.10% which, at the current balance, is $20.98 a year in earned interest.  I am contributing $100 a month into my Emergency Fund.

If I continue to save $100 a month, I will reach my goal of $5,000 in December 2012 and my Student Loan balance will reach zero by June 2014, a far cry from my ambitious goal of having it paid by May of next year.  On the other hand, if I apply the extra $100 a month that I am saving towards paying off my Student Loan, I will be able to reach my goal a year earlier.

There is another option.  I could throw all of my current savings at my Student Loan debt, which would lower this portion of my Student Loan balance to $8,789.68.  This would drain all of my savings and put me in a precarious financial situation and I am not honestly considering this as a viable option.

Clearly, the choice that makes the most sense mathematically is to focus all of my energy towards eliminating the Student Loan balance.  Mentally, having a cushion of money to fall back on is reassuring and allows flexibility in my lifestyle.

This money in savings (not my Emergency Fund) also allows me to pursue many of my ambitions such as travel.  It could easily be argued that until I have paid my debt that I should not be traveling.  Fair enough, though I believe that finding a balance in life is the key to happiness and I make sacrifices in other areas of my life in order to pursue my passion of travel.  I would not be happy without the freedom to move.

I’d love to hear your thoughts and opinions about my situation.  I know what I want to do but I feel like I would be making a mistake by ignoring my savings goal.

Filed under Debt, Emergency Fund, Money, Prioritizing, Savings, Student Loans

Pay Down Debt or Build an Emergency Fund?

May 7, 2009 3 Comments

"Emergency Fund" by newleoforex @ FlickrOne of the most debated topics in personal finance is whether or not to save money for an emergency fund or pay down debt as quickly as possible.  In this article I’d like to analyze the pros and cons of each in order to help determine which option is best for your specific situation.

Build an Emergency Fund First- Many personal finance websites and blogs recommend building an Emergency Fund before paying down debt.  Dave Ramsey suggests having $1,000 in an Emergency Fund before starting to pay off debt.

Pros- By building an Emergency Fund you are creating a cushion between your finances and an emergency.  By having this cushion available, in the event of an emergency you won’t be forced into a situation where you need to charge the expenses to your credit card.

Cons- Saving an adequate amount of money takes time.  When you are in debt, time is money.  Each day that passes is another day of interest charges.  Saving money also requires discipline.  Chances are that if you are in an uncertain financial position, you may lack the discipline to keep your fingers off of your savings.

Pay off Debt Fast- The alternative to building an Emergency Fund is to pay down your debt as fast as possible.

Pros- From a mathematical perspective, it makes more sense to eliminate the debt as quickly as you can in order to save yourself interest charges.  If you do encounter a situation that requires you to spend money it can be done on the card, then you just continue paying down the debt as you were before.

Cons- By paying off debt first you are eliminating the safety cushion of an emergency and are at the mercy of your creditors.  They have the power to raise your interest rates and lower your available credit whenever they chose.  This can leave you in a vulnerable position.

Which Approach is Better?- The answer to this question depends entirely on your tolerance for risk.  If you have a credit card with an available balance sufficient to finance the expenses of an emergency and are willing to put those expenses on your credit card, it may make sense for you to pay off your debt and sacrifice the savings.  If you are more interested in having a cushion between your finances and an emergency, it may be better for you to build an emergency fund before paying off debt.

My Opinion- When I began paying down my debt I felt more comfortable having something in savings.  I didn’t have Dave Ramsey’s suggested $1,000 saved before I began to get intense about paying down my debt.  While paying down my debt I continued to build my emergency fund each week; $20 here, $50 there.  Eventually I was able to build my emergency fund balance beyond $1,000.  Even though I didn’t have to use anything from my emergency fund while paying off debt, shortly after becoming credit card debt free I needed to pay for routine maintenance (tires, breaks, etc.) on my car, which cost me nearly $1,000.  If I hadn’t been saving all along these charges would have found themselves on my credit card.

What is really boils down to is what makes you feel the most comfortable.  You should be able to sleep soundly at night without worrying if you made the best decision.

Filed under Debt, Emergency Fund, Money, Savings

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