Emergency fund or debt payment?

diymadnessMarch 3, 2008

Hi all,

I just finished paying off my credit card and line of credit debt (took many years -- whew!). I still have an $8000 bank loan, a $4000 student loan, and my mortgage.

I was planning to keep hitting my debts hard, but I've read that some advise creating an emergency fund first, so that I won't have to use credit if an emergency comes up. I see the rationale, but I don't want to lose momentum in my debt repayment. I have a very secure job with health benefits and I have no children (plus I live in Canada, so health care is free). Potential emergencies could include house and car repair, or my old dog getting sick or injured.

What is your view? Should I keep paying down my debts, or stop and create an emergency fund?


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I've been caught without an emergency fund before, and nothing feels worse than that kind of major setback. It feels horrible to have worked so hard to get your debt down, only to have a problem and be right back where you started. Maybe you don't have to put ALL of your money into the EF, but I would put a majority of the money you have been using to pay down debts into it.

    Bookmark   March 3, 2008 at 5:46PM
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I have to say we got through thirty years without ever having the ideal "six months' expenses in a savings acct". It's a great idea, don't get me wrong, but we just never managed it.

What did get us through was having at least $3K in savings. Sometimes we'd come close to wiping the whole thing out, but automatic payroll deduction and an occasional tax refund dropped in, built it back up again after a while.

I agree with meghane - there's nothing worse than clearing out high-interest CC debt, and then having to run up a $2K bill for an emergency. There you are, paying 18% again....it's an expensive lesson!

Even now we only have about 3 months' expenses in savings. It works for us and we're comfortable with it.

Congratulations on being disciplined and paying off your debt! You're doing the sensible thing and won't regret it, I'm sure.

    Bookmark   March 3, 2008 at 6:28PM
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tishtoshnm Zone 6/NM

We are in the process of paying down debt too. Right now we have an $1100 emergency fund but we are trying to increase that. After we pay our minimums and other bills, we take what is left over and split it between debt reduction and savings. An overriding goal is to expand our emergency fund by one month's living expenses each year until we hit the 6 month mark. Another goal I am working towards is having a roughly 6 month reserve of non-perishables and household goods, so that when we do have a tight month, we can live off the fat in the pantry so to speak.

Dh has a very secure job but we also have 4 children and one of those has special needs so I know I would be more comfortable with a larger cushion. Other emergencies here could include, what if someone was in an accident and we wanted to take extra time off from work beyond available vacation (such as other family members). Another possibility here could be what if I was in an accident and broke my arm, as a transcriptionist, I could be out of work for a while. This is less of a concern for DH as his job provides both short-term and long-term disability coverage so we would only be on the hook for 1 weeks costs before that coverage sets in.

Good luck with the debt pay-off, you are getting closer.

    Bookmark   March 3, 2008 at 6:37PM
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Hi diymadness,

Congratulations on having got your credit card and other debts reduced substantially. That means that there's a lot less load on your back to carry.

You speak of having a bank loan. Are you paying a fairly high rate of interest on it at present? Is there collateral backing it?

Could you expand it easily in case you have an emergancy and need some money unexpectedly?

If not, would it be possible for you to set up a line of credit, whether based on your home equity, or without an asset to back it?

Do you have any business with a credit union? Is there one in your area? I like the idea underlying them - the people doing the business are the owners. Sometimes they are more ready to allow a person with good credit to have a naked loan without charging an arm and a leg for interest.

Is/are your credit card(s) still available, or did you cut them up? If available, have you proved yourself capable of forebearing using them till you have enough money on hand to pay off the amount owing in full each month as the bill arrives?

If you still have a credit card, and can either add some more to the current bank loan, or obtain a line of credit, whether based on your home or naked, if I were you I would be less worried about setting up an emergency fund until you have more of the debts paid off.

If you have an emergency - a *real* emergency, not just a fleeting want - maybe use the credit card to pay it, then before the first payment is due on the card arrange an increase in your current bank loan, or use some of the available credit on the Line of Credit to pay off the total amount owing on the credit card - the bank loan interest will be at a lower rate than on all but an introdutory low rate on some credit cards.

If you have some "windfall" income at times, or have an income tax refund, etc., you might be well advised to put some of that type of money into building your emergency fund, as well as paying down the debt, at present.

Later, when you get more of the debt paid down, institute a savings plan to save and invest a small amount from each paycheque to put to work for you. In fact, it'd be a good idea to start that now, even though it's only a small amount per paycheque - it's the most important discipline realted to saving and investing.

Don't forget - paying down debt is the equivalent of getting a (tax-free) raise in pay, as money that you were using to pay that "down a rathole" interest on loans/credit cards (which was usually paid with after-tax money unless the loan had been used to fund a home-based business) then is available in your pocket to use for other purposes.

When you speak of health care being "free", I assume that your meaning is that you don't have to pay out-of-pocket when you use it.

Some provinces and territiories provide health care without a levy on the individual/family and some charge a regular fee to individuals and families, I think.

For years in Ontario we had a health-care premium (Ontario Hospital Insurance Plan - OHIP), which was reasonable. Then the government cancelled it several years ago, and a later government which, when running for office, had promised, "no tax increases", when they got into office realized that they had serious financial issues, so instuted an "Ontario Health Levy" ... an annual fee payable along with our provincial income tax - but *not* a *tax*, you understand.

Good wishes as you proceed with your financial and lifestyle plans.

ole joyful

    Bookmark   March 4, 2008 at 5:03AM
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The emergency fund is most important !!! As other posts have mentioned, how much of a fund (3mo? 6mo?) is a matter of opinion. Since you don't want to lose momentum, just consider your EF another debt. Keep paying into it like you did your credit cards, and go straight from building up the fund to your other loans.

Good luck!

    Bookmark   March 4, 2008 at 1:13PM
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I agree, I would set up an emergency fund first (or at least create a separate account and start contributing to it)

Here in the USA we get to declare our school loan interest on our taxes so we will pay off our school loans and mortgage (which has similar "benefits") AFTER our car loans or other loans. We are paying off our car loan that has the higher APR first.

I use my emergency fund as my "pay off" fund too.

I use a money market for this as there is a high interest rate with money markets. If I want 5 grand for my emergency fund and my car has 10 grand on it I save up until I have 15 grand and then pay off my car. This means I get a lot of interest from the money market and I have a larger fund of money for an emergency cushion.

If say, my car is stolen and I need a new one or something else like that happens I always have money to play with to put a new downpayment on a car or whatever I need. If I just kept putting money in the car loan without saving it in the money market first, I wouldn't have the ability to do this.

I am luckily very good at saving my money though and never have a desire to touch my emergency fund (that 5 grand or whatever I feel is 5 months of living expenses) or use my "extra" savings for non necessary expenses.

If you own a house having an emergency fund is SO necessary.
what happens if your furnace dies today? Can you easily go out and buy a new one?? Our house is older so i can't TELL you how many little things broke that we had to replace ASAP. Even newer houses have things break too, so it is just best to plan for that and not be upset when/if it happens. We also have an inground pool so we also saved money for a filter failure and two years ago our filter cracked and we had to go get a new one. So not only should you save money to pay your mortgage, (health care if you are in the USA), and food but you should save for "house" emergencies too.

Everyone works SO hard and it is terrible to see families sink into debt because they did not plan for something as simple as losing their jobs.


    Bookmark   March 4, 2008 at 3:16PM
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Personally, I cannot imagine being without an emergency fund--we started our marriage with the understanding that I'd be quitting work when we started our family, so from the start, we banked my salary and lived on my husband's. We NEVER took out any debt other than the mortgage on the house we bought.

Even on a low salary, you have SO MUCH more spendable income if you don't have a lot of high-interest debt to pay back. When you sit down and figure that by charging and paying interest, you can end up paying 2-3-4 times the ticket price of the item you're buying, it really makes the point that debt is expensive.

At this point, though, you have the debt, and your interest is high--much higher than you will get on any money invested right now. Financially, I think I'd take the gamble and continue to hit the debt hard to save on that interest. Then once that's out of the way, you'll want to be just as enthusiastic about building your emergency stash. Now, I say that, assuming that, should you find yourself in an emergency situation, you can increase your debts to cover it? If that's the case, you may just come out ahead by working on those debts first, IF no major emergencies hit. Also, keep in mind, if you do find yourself in a precarious situation, there may be some state or federal help available to you (there are a lot of programs that help with food, housing, utility bills, medical, etc)--but not if you have money in the bank. I'm NOT a fan of people living off the dole, but the occasional, short-term emergency is the right way to use that kind of help.

    Bookmark   March 5, 2008 at 10:13AM
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azzalea, I'm confused. You first say you can't imagine being without an evergency fund, and then advise somebody else to take a gamble and go without one.

diymadness, if you are tempted to go with the minority opinion of delaying your EF, at least consider a compromise. Set up a savings account (or something liquid) as your EF and start putting SOMETHING from each paycheck in there. Even if you are also hitting your debts at the same time.

    Bookmark   March 5, 2008 at 2:04PM
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Where are Annie, Dave, and Deer. on this one? The silence is deafening.

I can't "relate" to heavy indebtedness. I've never been "buried" by debt; I pay my credit card balances in full every month and I always have. I've always paid myself first and I've been investing regularly for a long time now. I pay to principle on installment loans and always have. Some would say that's a bad habit. But it works for me. And it keeps me comfortable.

I have close to one year's net salary in "liquid" savings. If I need it, I can get to it! But it took me a pretty long time to get there, too (the better part of 5 yrs. with regular contributions and some "setbacks"). I pretty much worked my tail off to maximize retirement savings and by "livin' lean" managed to funnel money into my "emergency fund". The "emergency fund" was pretty "underfunded" for several years, frankly. I played the odds and I came out on the winning side, maybe I was lucky. I am not the person to "run the numbers" and tell you what choices you should make relative to debt and "emergency".

I can tell you, though, that it's nice to know there is a cushion against unforeseen expenses. So I'd advise you to split the difference between the two. And REfocus on minimizing expenses you can control.

Bring your lunch to work.
Unplug "solid state" appliances.
Allot yourself a fixed amount of "pocket money" weekly. Use it wisely. When it's gone, it's GONE. Go without until payday.
Pay with BILLS. Pocket the change and put it in a can. At the end of the month, put the "savings" toward outstanding debt.

None of this is glamorous. None of it is easy. But none of it is hard, either. But it does require that you refocus your attention from lofty goals to pretty "down and dirty" ones. Hang in there!

    Bookmark   March 5, 2008 at 5:22PM
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Thanks everyone. I appreciate your advice. I think I will compromise and divide my extra money between debt and starting an emergency fund. It hurts a little to put that money away instead of spending it on the the good things in life. But I figure it will be worth it in the long term.

Thanks again.

    Bookmark   March 6, 2008 at 3:32PM
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Below is a link to a very useful site. I've been a member for several years now and have gleaned much excellent information from it. Scroll down and look for message boards. They're pretty "free wheeling", can be brutally honest. It's a great resource.

Liz. Pulliam Weston was a guest on an NPR news show a few days ago and the focus of the discussion was dealing with credit card debt. You may be able to find it if you go to the National Public Radio website and search for her name.

Here is a link that might be useful: Fun site; join up and enjoy

    Bookmark   March 6, 2008 at 5:22PM
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Great link - thanks for sharing.

    Bookmark   March 7, 2008 at 3:22PM
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Hello do it yourself madly,

You refer to having paid off your credit card debt, and your Line of Credit loans.

Now you have a bank loan, student loan and mortgage.

What rates of interest are you paying on those loans, now?

I assume that none of the loans were for deductible things, so none of the interest payments are deductible.

If you build some savings, it'll likely be in a savings account or a money market fund, neither of which pay a fairly high rate of interest. Furthermore, the interest earned is taxable, so the amount that you have in pocket after the tax is very small.

Not only that - the amount of money in your account, while you have a guarantee that they'll give back every dollar that you gave them ... they won't give you one single dollar more, either (apart from the interest, or rent, on the money).

However ... the value of each of those dollars shrinks each year, due to inflation: it'll buy less on Dec. 31 than it would have on Jan. 1 of that year. Which means that you need to put part of the earnings with the principal in order to keep your purchasing power intact.

After you lose both of those amounts from the earnings on your saved dollars ... there's darn little left for you! But ... it may be a good way to go ... see below.

Is that line of credit still open? What is the relative rate of interest on it and on the bank loan that you are paying down now? If general interest rates change, does the rate change on your current loan? Quite likely it would change on the Line of Credit, were you to retread that.

Is your credit card still available? Or do you have more than one? What kind of limits on them?

If you could use either or both of those two sources to cover your need in case of an emergency, I'd be tempted to start building a small level of savings while paying down those current loans, making the largest payments on the one with the highest interest rate.

And I'd try to live quite frugally, making a really strong effort to get them paid down sooner rather than later.

After restarting my current Line of Credit, if I had an emergency, I'd use the credit card (and it really is a "debt" card, don't forget) to finance the cost.

Since it's almost certain that the rate of interest is much higher on it than on your Line of Credit, before the due date of the payment on the card, I'd restart the Line of Credit and use it to pay off the balance on the card ... in full!

And I would make that a rule - keep that card balance paid in full prior to every due date - that interest rate on it is far too high!! Do you know how high it is? You should!

Then ... the re-opened Line of Credit becomes one more debt to pay down, and which one gets the extra payment first depends on which interest rate is highest.

If you feel that your credit card teamed with the former Line of Credit, assuming still available, are sufficient current coverage for emergencies, then maybe start some modest savings, in a savings account to start.

Start planning what to do with the savings when they build up, and I recommend putting a substantial portion of them into equities, aiming at some growth to offset inflation.

Three choices, I think.

1. Many choose regular traditional mutual funds to start, allowing one to get a small piece of various parts of the market with a small amount of money invested (diversification). Some are available at low/no commission, but it's important to choose one/some with good long-term growth record.

A major problem is that most Canadian equity fund managers charge 2.5% management fee annually ... and when one considers that long-term average market growth runs 6 - 10%, with the probablility of being closer to 6% for a few years ahead, largely due to U.S. financial problems, that's a fairly hefty fee. (I've owned one bank's shares for 41 years. If a mutual fund, that'd have cost over 80% of the original asset value, without accounting for compounding - and the 2.5% and up is of each year's value, ongoing).

When you have maybe $2,000. or more invested, ask your lender holding your loan whether they'd offer a lower rate if you offered some good collateral. If you can offer, say, half of the amount owing, they may reduce the interest rate somewhat. To get the best rate you need to be fully secured, that is, $2.00 of equity value for every $1.00 of loan ... and if the value of your equity goes down, they'll want some more equities ... or cash to reduce the loan. With a good offer, have your advisor have certificates issued (almost always no fee involved) for the number of units that you own, then take them to the lender to lodge as collateral backing the loan.

2. Investors can get a piece of a number of companies in various parts of the market, e.g. transport, consumer products, oil and gas, metals, financials, gold, etc. by buying Exchange Traded Funds through stockbrokers. That achieves much of the benefit of using regular mutual funds, but the managers almost all charge less than 1% of the value of the funds: much below the 2.5% or so of the regular funds.

There's a possible problem: certificates for the units aren't available, so can't be used as collateral to reduce interest levels on loans.

Check the full-service and discount stock brokerage firms related to your current bank to see how pleased you might be with their service.

Do you have a credit union near you? I like to use them, other things being equal, for the users are the owners and whatever profits they make stay there. And I've long owned shares in a Canadian bank.

Does your local credit union relate to the Q-trade or other discount stock brokerage agency?

If so, it might be useful to start a savings account with them, along with paying down the loans.

I suggest that you visit your local library and get "Canadian MoneySaver" magazine, June 2008 issue, and on pp. 16 - 18 you will find a list showing the various charges which a score of discount stockbrokers make for their services.

Check which one is related to your current bank and see whether you like its offer ... or pick one that you'd prefer to use and set up your savings account with a bank that is associated with that brokerage firm.

Perhaps interview a consultant that helps people manage their money well with your candidate agency before you set up your account to see how well you might like their service.

3. Buy individual stocks directly. The main problem with that is that part of your invested money is all in one place, so you're at the mercy of your chosen company's results. A major benefit: once you've paid commission to the broker to purchase the stock, there are no management fees as long as you own it (another commission when you sell). Also, it costs usually about $50.00 to have share certificates issued, to use as collateral to produce a reduction in interest rate on your loan. Which would deter you from having them registered, if only a small reduction of interest rate offered.

If you look on P. 33 of the June, 2008 "Canadian MoneySaver" magazine, you'll find a list of various stocks which allow you to have dividends reinvested.

When you have more savings ready to invest, when you own shares in the companies on that list, you can purchase more shares directly from them at no or minimal fee.

I think that you'll find that almost all of the stocks on that Dividnd Reinvestment - Share Purchase Plan list are quality companies, and you can invest in them, over time, with confidence: some are better than others.

Ask the people in the Business and Money Management section of the library to show you some ways that you can learn more about various stocks, and you can investigate some of the stocks on the Dividend Reinvestment list.

Also, if you look on p. 4 of "Canadian MoneySaver", you'll find a list of about 35 places in Canada where the subscribers to that magazine get together, usually monthly, to discuss investing. If there is one near you, you'll get some good ideas there about which stock to buy, as well. We usually have about 20 attend the London meeting, which has been going for over 10 years ... I've been attending for about 7 years, I think.

As time goes along, you'll want to choose other stocks in which to invest, in order to be involved with various areas of business - usually if one isn't doing well for a while, another is doing better.

After your debts are paid off, perhaps find out whether, when you have several thousand saved and invested in stocks, whether the other financial agency from the one which carries your current Line of Credit would lend you about 1/2 (maybe 2/3, but that's a bit high) of that amount, to add to your investment.

A while ago I'd have to have paid 6.25% interest on my Line of Credit, when I use the loan to invest, the interest is deductible, which at 25% tax would reduce my cost to 4.69% (at 20% to 5.0%). If the stock earns 3.0%, there's a tax advantage, so I'd have about 2.5% left after-tax, which takes my cost down to 2.19%. Plus, I gain from inflation (if I agree to pay iterest-only as I go, I pay back exactly what I borrowed - which will buy less than when I borrowed it: I gain from inflation ... the guy who put his money into the bank lost).

Now, the bank wants 4.75% if I draw on my Line of Credit, so my effective cost is nil.

Good wishes for increasingly skillful management of your income ... reductioon of those debts ... and building of assets.

ole joyful

    Bookmark   June 6, 2008 at 8:16AM
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Assuming you have an income coming into the home, i would just review what type of emergency would come up while paying down the debt. Car, medical, etc. i would guess you may only need $1-3k in the bank for such emergencies.

get that amount and then pound the debts until it is paid off. whether something is tax deductible or not doesnt matter just pay it off.

good luck.

    Bookmark   June 7, 2008 at 12:06PM
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I'm in the minority, but (assuming the credit cards are still current and usable), I'd keep paying as much as possible to the credit cards and use them as an emergency fund if absolutely necessary. I can't see how you wouldn't come out better that way, even if you do have an emergency that puts you back where you started.

What am I missing here?

    Bookmark   June 11, 2008 at 2:10PM
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What joann23456 is missing is that if you lose your job, you might find your credit cards frozen too.

    Bookmark   June 11, 2008 at 2:31PM
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I'm also with paying off the debt, saving all that high interest. I know, I know other's disagree, but that's my story and I'm sticking to it.
How would the card company know I lost my job?

    Bookmark   June 11, 2008 at 5:18PM
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Cmarlin20 asks "How would the card company know I lost my job?" Well, for example, your former employer might tell them.

    Bookmark   June 11, 2008 at 6:08PM
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True, I suppose that could happen. It's a risk I'd take, though. In fact, I did take it when I was in a similar situation.

    Bookmark   June 11, 2008 at 7:20PM
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Cmarlin20 asks "How would the card company know I lost my job?" Well, for example, your former employer might tell them.
How does my former employer know whom to call, and why would they spend their time doing this.
This is a real question. .. now I'm getting confused about this thread. This OP has a or several credit cards. OP loses job, ex employer call the credit card company to tell them OP is no longer an employee. Have you ever known that to happen? Do they call Chase bank or each bank for each ex employee?

    Bookmark   June 11, 2008 at 10:02PM
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There is no way that the credit card company would know that you lost your job.
A former employer would never call around to various credit card companies in the hopes that they could find the one that you do business with. What would be the point? I think you're a little paranoid.

    Bookmark   June 12, 2008 at 9:10AM
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greg_h calls me paranoid when I say that a credit-card company might find out that you lost your job.

I didn't mean to say that the employer would contact the credit-card company directly. Rather, I have no trouble imagining a situation in which an employer arranges with a credit bureau to do credit checks in bulk on prospective employees, and gets a discount in exchange for telling the credit bureau whenever it hires an employee or an employee leaves.

The last time I checked my credit report, it included the names of my past employers. I certainly didn't give them that information; but they got it from somewhere. Is it really paranoid to believe that a credit-card company, which surely checks their customers' credit reports from time to time, would have access to that information?

    Bookmark   June 12, 2008 at 9:28AM
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Ahhh. I guess that's possible. Maybe you're not paranoid after all. :)

Thanks for clearing up what you meant. I wasn't the only one that interpreted your brief previous response the wrong way.

    Bookmark   June 12, 2008 at 12:02PM
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The last time I checked my credit report, it included the names of my past employers. I certainly didn't give them that information; but they got it from somewhere. Is it really paranoid to believe that a credit-card company, which surely checks their customers' credit reports from time to time, would have access to that information?

Have you ever seen a credit report stating unemployed? Yes, your credit report shows a employer as reported on your app, not normally confirmed by a CC company but a larger loan such as a mtg.
I can't believe a company would risk the liability of reporting unemployed to a credit agency.
As I said the actual place of employment is not of much importance to a CC company, only the payment history.
Paranoia or not, don't see it happening.

    Bookmark   June 12, 2008 at 12:29PM
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Start an emergency fund now diymadness. Go to minimum payments on all loans until you get 1K built up in the Emer. fund. Put it in an account not a glass jar and do not touch it unless you have to! Then get back on that debt hard, cut out anything you can do without and pay off that debt....then never borrow again if at all possible. Preach to yourself "debt is bad", it will change your life.

    Bookmark   June 13, 2008 at 10:52PM
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