Hypothetically: Debt or Emergency Fund?

[b4freedom]

Hypothetically and in your opinion, what is more important: having an emergency fund of $20k and $20k in debt or zero debt and no emergency fund?

Let’s assume that I have a student loan for $20k at 5% for 20 years. I can pay an extra $1000 a month for the next 20 months, or I can put the $1000/month into an emergency fund account earning 5%. There are no other missing facts to the equations and it’s all or nothing, you can’t split it and pay ½ towards a loan and ½ towards savings. What would you do?

If there is a huge disaster or emergency are you going to wish you had the $20k to get you out of the situation and would you be less worried about that monthly student loan payment?

If you didn’t have the $20k, would you have to take on more debt (credit cards) to get you out of the situation?

Do you think it’s better to just get out of debt first and then save for an emergency fund?

What if the rates changed? What if it was credit card debt and the rate was 18%. At what rate would you change your mind to eliminate the debt before saving for an emergency?

[Ima saver]

In my situation, I could not sleep nights knowing I had no cash in the bank. I have had a bank account since I was about 7. I would have the $20,000 in the bank and pay all I could find extra on the loan!

[sweeps]

I would do both EF and debt reduction. But since you're saying it needs to be either-or, I would go with EF until the debt was about twice the rate of the savings rate, then I would switch to debt reduction.

[autoxer]

I would rather have zero debt and no emergency fund. I'm comfortable without an emergency fund at this point, although that may change when I do have a mortgage or a family.

[TinyFish]

I'm with sweeps. Ideally, I think I'd do some debt reduction and some emergency fund. Are your (hypothetical) expenses really 20K for 3-6 months? I imagine these student loan payments are not huge, so you could relatively easily cover them for a few months with an modest emergency fund. Then it just depends on what other obligations/debts/expenses you have. I assume you have rent, etc to pay and your food, at a minimum.

If forced to choose one or the other, I'd go with the emergency fund. The reason being, if you get into trouble (say, lose your job), you'd want to be able to make those payments and meet any other obligations rather than going further into debt (possibly 'bad' debt like Credit Cards) and possibly doing very bad things to your credit.

-TinyFish

[TinyFish]

Oh, and another thing. There is another aspect to an 'emergency fund'. While I think we all tend to think of more financial emergencies (you lose your job, have an illness, suddenly need to replace something like a car or a component of your house), there is another side.

What if there was a serious, dangerous emergency? For example, what if there was a natural disaster in your area? I remember reading about people from New Orleans who either a) got out, but then had no money to cover even a few days in a hotel in a safe area or b) couldn't get out at all because they had no money for transportation. Wouldn't you sleep better at night knowing that you had the money for a bus ticket out and for a safe place to stay and some decent meals? What if your apartment building burned down and you had to temporarily stay somewhere more expensive? Or you had to replace all your clothes because all you got out with was the jammies you were wearing?

I'd say you'd want at least a small emergency fund no matter what. 20K all or nothing? Well, almost nothing in life is all or nothing.
-TinyFish

[Ima saver]

You make a very good point tinyfish. that is why all those people were given cash in the amount of about $2000 each. For some, it was the most money they have had in their entire life.

[TinyFish]

Yes Ima, though I'm thinking more of before the storm and in the early few days after. I'm sure some poor people lost their lives because they did not have the financial ability to flee early enough. What a terrible price to pay for not having a little ready money, for whatever the reason.

[creditcardfree]

I would have to say the emergency fund first in this hypothetical example. I've always had some sort of savings...for many years it was less then $1000. So I can't imagine not having anything in case of an emergency. I know of too many people without emergency funds...and only credit cards...leading to more debt.

But in real life, I'd save a small emergency fund...$1000 or even one months of expenses and then attack debt and then go back to the emergency fund.

[creditcardfree]

All of you bringing up the hurricane, reminds me that I really should pull out some cash to stash here at home. I think if I were to look for cash in the houseright now, I'd have less than $1...not good in an emergency.

[Diolla]

There is also a big difference between paying off student loan debt and CC debt in this scenario.

If it is CC debt then every dollar you pay gives you that much back in available credit. If you pay off student loans that is it, nobody's going to let you borrow that money again (unless you become a student)

I would be much more likely to want an EF and wait on the Student loan and pay off the CC because I could use the CC if there was an emergency.

Hypothetically.

[LuxLiving]

60% student loan
30% emergency fund
10% now (upkeep on vehicles/house repairs - more insulation, full tank)

----
100%

Okay - I'll say the unsayable - IF, it was truly a Capital E - "E.M.E.R.G.E.N.C.Y. Emergency" and you had repaid on your loans and were up to date - you'd be in a fine position to use those dratted CC for the purchase of a tank of gas to get you out of Dodge, or a couple of pair of jeans for the family who bugs out w/o their 'stuff'.

[TinyFish]

Personally, I'd like to have access to some cash for the uppercase type of emergency. Who knows if the phone lines will be working for credit cards, and you might have to pay for your bus ticket or something in cash. Many poor people in big cities (or even non-poor people) don't even have a car to fuel up, so they would have to buy public transport of some kind, or maybe pay someone for a ride in their car.

Credit Card Free makes a good point. I should do more towards our disaster preparedness kit, including a stash of cash!

Also, I suppose it is possible that someone would have no credit card at all (or all maxed out) and need to 'get outta Dodge'.

-TinyFish

[Broken Arrow]

Interesting!

While it may be a hypothetical question, it does strike close to home for me, since this is something that I am currently working on.

I think it's important to qualify that I believe the answer will vary from one person to another. We all have different levels of risk tolerance and probabilities of experiencing a potential disaster.

That said, I for one have chosen to pay down my student loans first, followed by topping off my emergency fund right after that (as shown in my signature).

Despite what's going on in my personal life, I am in good health and I am currently content with my relatively stable job. Therefore, I believe that I can "afford" to pay down my student loan first.

Also, please note that paying down a 5% loan is not the same as saving it in a 5% interest savings account, because the interest on latter is taxable. (5% of 20k comes out to a nice, round 1k. So, depending on your taxes, it could be a difference of $200-$300 each year.)

Now, if an 18% credit card was thrown into the mix, my answer would definitely shift to paying down the credit card (which is what I did, as noted in my signature). Not only would I save even more in the long run, but in an emergency, I can draw funds out of it again. Yeah, I know it's not a good thing to do, but in an emergency, you can at least take comfort knowing that you can do that if you had to.

Of course, as others have mentioned already, I realistically do a little bit of everything, changing what I focus my money on as I see fit. However, I do agree that having some kind of EF is very important to have, generally more so than paying down a low-interest student loan. Still, while I am open to suggestions to the contrary, I don't think that what I am currently doing is a bad idea (especially with a baby emergency fund in place).

let's wrinkle this sheet up a little more by adding that sometimes whether a "situation" becomes an "emergency" is entirely dependent on how beholden you are to other entities.

meaning since I don't owe anyone a cent, even a big unforeseen whack upside the head does only limited damage because there's nobody for me to fall behind with. my only concerns are a place to live and keeping the utilities going (obviously in a Katrina like situation, even that's not an issue as you have to find a new place with new utilities).

granted, these are important concerns to be sure but they're equal across the board for everyone. I wouldn't have the added weight of trying to keep up with a car payment, credit cards, loans, etc., something that is very important to me.

that makes me feel better establishing a small emergency fund and then wiping out the debt. for me it's not just the interest and numbers (although I am certainly an interest and numbers type of guy!) no, this is one place where the feeling of security overrides what may make better sense. in my case, the security comes with the freedom from debt/obligation.

I do like the idea of enough cash on hand to get you out of the situation in an example like Katrina, once you make it to a stable area, the electronic financial world will be available to you again.

let's hope God and fate spare all of us from having to ever use that cash.

[safari]

Originally Posted by Broken Arrow

Also, please note that paying down a 5% loan is not the same as saving it in a 5% interest savings account, because the interest on latter is taxable. (5% of 20k comes out to a nice, round 1k. So, depending on your taxes, it could be a difference of $200-$300 each year.)

The inerest earned is taxable, but don't forget that the student loan interest paid is tax deductible (in most cases). So this is pretty much a wash.

[creditcardfree]

Originally Posted by Broken Arrow

Still, while I am open to suggestions to the contrary, I don't think that what I am currently doing is a bad idea (especially with a baby emergency fund in place).

I don't think what you are doing is a bad idea. I think it's good. You have an emergency fund that would keep you from adding debt on a CC in most situations. You are knocking off that debt quick too...so that makes what your currently doing A-OK in my book. Good job.

[puck36]

Originally Posted by b4freedom

Hypothetically and in your opinion, what is more important: having an emergency fund of $20k and $20k in debt or zero debt and no emergency fund?

I would say 20k in an emergency fund an $0 debt. Why would you want any debt other than a house? I'm a big fan of Dave Ramsey.

[sweeps]

Originally Posted by puck36

I would say 20k in an emergency fund an $0 debt.

Unfortunately that was not one of the options.

[lrjohnson]

Originally Posted by Sweepsplayer

Unfortunately that was not one of the options.

I'd take the pizza, with an ice cream sundae. Or, sushi. I'm not so picky.