Saturday, January 28, 2012

Emergency fund versus student loan payoff

This morning I was thinking about the tradeoff between building an emergency fund and pre-paying student loans. I'm not the first one to approach this question; the internet is abuzz with different perspectives. The consensus, as best I can tell, is "it depends". There are pros and cons to both approaches. Life is full of tradeoffs after all.

But why am I again considering a change in course, again? This time it's because of external factors. My girlfriend's company is going through a round of layoffs so she's been feeling insecure in her employment situation. I don't think she should worry — it seems they're trying to cut costs by getting rid of people with longer tenure and higher salaries — but honestly you never know. She would feel more comfortable if we had a little more of an emergency fund.

Security is a big benefit of an emergency fund. Of course, you can save money in interest if you take more risk and throw all your extra cash at your debt. Increasing your cash decreases risk, and so does decreasing your debt, but they're not symmetric. Just because I'll be paying less interest on student loans doesn't mean I won't have the mortgage coming due every month. There's also security in having two incomes in a household. Honestly we could keep up our expenses for a few months on just one of our salaries, though we'd cut out pretty much everything if one of us lost our job.

My philosophy is that, in general, you should keep exactly enough cash so that you can sleep at night, and no more. This is when you've got non-mortgage debt that you're working hard to pay off. If your living situation is flexible enough and you're confident you can cut expenses if you hit some financial turbulence, I say keep savings to a minimum and save money on interest.

How is our emergency fund stacking up? Between my girlfriend's savings account and the $1k in our joint savings, we have like three months of mortgage payments that we can count on. And we've been funding the joint savings at around $500/month. Then there's my savings. I made a deal with her that I'll save up $3k and keep it until her employer settles down with all the layoffs. That would be another month for the mortgage, and after she's more confident in her employment I'll be able to turn around and throw it at my loans.

I have somewhere between $1200 and $1700 in savings depending on how much ends up on my credit cards for January. By the end of next month I should have the $3k, the bulk of which I'll probably put in my 401k-loan-prepayment fund. This also means I'll most likely not send in a student loan pre-payment next month. Bummer. But it's worth it if it helps my girlfriend sleep at night.


  1. Debt or savings? It is the eternal question isn't it? You hit the nail on the head, "it depends." If your debt is zero interest (possible with student loans) obviously pay the minimum and let inflation pay the rest! If not then... it depends.

    I found that whatever keeps you motivated is the best course. For me I really enjoyed seeing huge chunks of my student loans or credit cards fall away and therefor went the path of making $2,000-$2,500 a month payment on them. Sure I didn't have any savings but I stayed motivated and my employment was relatively secure. Now that I'm finished I have moved that motivation to savings and investing.

    Sounds to me like you are making all the right moves for your situation. After all the only "wrong move" you can make is to do nothing.

  2. Hey The Kechi One,

    I totally think that motivation is a large factor here. Besides the don't-be-charged-usurious-interest-rates factor, pay down loans and fund your savings accounts in proportion to what makes you feel best. In both cases you're moving toward Mustachianism.