There is a financial cage match article that I can’t write: debt vs. the emergency fund.
It’s not hard to see why there isn’t a one-size-fits-all answer to question of what comes first before the other. How much debt you have and how long it will take you to pay it off matters. If it will take you five years to pay off your debt, do you want to go that long without having a full-funded emergency fund? On the other hand, if you have as much debt as you do an emergency fund, doesn’t that make little sense?
It’s that last point that’s worth talking about today, as a way to manage the conflict between the short term feeling of security and the need to get your financial life in order.
Table of Contents
Let’s set the stage
You, like most people, have some amount of debt. Putting mortgages aside for now (which are usually an order of magnitude higher than any other debt), you could have thousands or even tens of thousands of dollars in debt.
Now, in the other corner, you have an emergency fund. This is your reserve of money that you use when emergencies happen.
I believe very strongly that everyone would be best served by having six months of bills and expenses in the bank as their emergency fund. As in: if you earned no income for six months, you could live on the money in your emergency fund. That’s a lot of money. (Here’s how much you need.)
But the two are at cross-purposes, aren’t they? I mean, does it make sense to sock away money at the same time as trying to use your money to pay off your debt? Do you do one then the other?
But I’d be lying if I said that that was exactly how I did it.
Instead, I used what I called the “debt blunderbuss”.
There is a huge feeling of security in having an emergency fund. Just knowing that that money is there, waiting to be used, can have such a huge soothing effect. And to someone like me to whom financial security is so important, that feeling was not something I was willing to give up easily.
And that is the argument people use for suggesting using most of your emergency fund (if you have it) to pay off debt. You’ll get rid of the debt faster, and you’ll be more motivated to finish the job, so you can build up your emergency fund again.
I get that, but I guess it depends on your tolerance of insecurity. If you can handle having a very little emergency fund for the time it takes you to pay off your debt, then great. But if not, what then?
There is a middle ground which I found for myself.
My story is that I was down to my last student loan. I was throwing everything I could at it, determined to have it out of my life. Once I realized that there was no such thing as “good debt”, I was on fire.
But not so on fire that I was willing to touch my emergency fund. It provided too much security.
This didn’t make financial sense, and I knew it. By using some or most of my emergency fund to pay down the debt, I could have saved hundreds of dollars in interest payments (as I would have reduced the principal along the way).
Sometimes though, it’s not as important to make the numbers add up in the short term, especially if making the numbers add up will increase your level of discomfort to an intolerable level
So here’s what I did: I left my emergency fund intact until my debt level became equal to my emergency fund.
And then I blew away my entire debt at a stroke by using my emergency fund.
Now granted, afterward I had no emergency fund, and therefore I needed to build it up. But this was a tolerable form of discomfort, and especially so because I had no debt payments. I just put everything I had into building it back up again.
And it didn’t take all that long to build up my emergency fund back to the level that I needed it to be. In my situation, it took less than a year, with each month adding a little more security.
Perfect, meet Good
The best financial plan is to use most of your emergency fund (except for $500 to $2,000 for smaller emergencies along the way) to immediately pay down your debt.
But if you already have that emergency fund and getting rid of it seems too difficult to bear, then you can always hold on to it and pay down your debt until such point as your debt level is equal to your emergency fund.
And at that point, get rid of it all at once.
But enough about me. How do you handle debt with an emergency fund?