Paying Student Loans with Emergency Fund

[Deimyts]

Here's my question:
My wife and I have been focusing hard on paying off my student loans, and we're a few months away from knocking out the biggest one, which was originally $26000 @ 9.5%. Our income has increased recently, and at the end of this month, the balance on this loan will be about $6,500. We're paying between $2,500 and $3000 towards it every month, and so, if everything stays the same, it should be paid off by August.

In addition to the loan that's almost paid off, I have a lot of smaller loans, at lower interest rates, totaling about $52,000. Once the big one is gone, these should fall pretty quickly, one by one.

We have a $3,000 emergency fund in a high-yield savings account, and in addition, we keep a fluctuating balance of $1500 to $3500 in our checking account, to ensure that money is always there when monthly bills are automatically withdrawn. The emergency fund is enough to cover  2-3 months of bare-bones living expenses, not including our loan payments, which can be skipped or drastically reduced if needed.

As the loan balance gets smaller and smaller, I find myself wanting to do whatever possible to reduce it further, and it gets harder and harder to wait. August seems like forever!

So, I find myself wondering, do we have too much put aside for emergencies, since technically, that massive debt is an emergency too? Should we reduce our emergency fund to get the debt paid off sooner? If so, how much is appropriate?

To add to the complexity, my wife's job is contract based, and is likely to end in June. Her contract might be renewed, but it isn't a sure thing. My salary is enough to cover our expenses and continue making loan payments, but we'd probably reduce our monthly payment from $3,000 to $1,500 until she can find a new job.

So, Mustachians, what should we do? Raid our emergency fund to pay off the loan about a month earlier, or be patient and conservative?

[Kris]

In your situation, personally I wouldn't take money from your emergency fund.  My main reasons for saying this:

1) Your wife's contract employment status and likely end date
2) Your emergency fund isn't all that big (only 2-3 months' expenses) and also won't knock off that much of your students loans. 

Given those things, I don't think it's worth sacrificing the amount of security the fund gives you in exchange for paying off your loans only one month earlier. 

[slugline]

Do the math -- On a sum of $3000, 3 months interest at an an annual 9.5% is about seventy bucks or so, right? Is seventy bucks worth the risk of wishing your emergency fund was there between now and when you would be in a postiion to replenish it?

[Numbers Man]

I agree with the great advice from the previous posters.

[Bob W]

I would check out SoFi to see about refinancing that stuff.

Not a big proponent of emergency funds.    If you have credit cards those cover your so called emergency.   I think E funds are really more appropriately called contingency funds,  fun funds or zero interest funds.   

Here is the reason I don't like them.

You have 3K setting there earning zero.    Take that 3K and invest it for 60 years.  (yeah,  I know, probably only your kids or grandkids would benefit right?)

In 60 years you will have 500K in inflation adjusted money and your kids will think very highly of you.   Let it sit in an E fund and you will have $500.   Ask your kids if they would rather have 500K or 500. 

The other issue with E funds is they vastly increase your likelihood of spending them or other funds mostly on wants.   

Washer goes out "wow, emergency,  good thing I have this pile of cash"   You could have DYI fixed the thing for 20 bucks but instead you spend $500 for a new one because you are such a great saver and planner.

Aunt dies at age 78 this summer --- "well I haven't seen her in 20 years so I guess I should fly my wife an I to the funeral"  bam there goes $900.

So answer this --- if your checking and savings accounts say zero and you are hardened against credit cards are you more or less likely to spend money?

IMHO E funds are best for people who have had problems with credit card debt and budgeting their money.   You seem to have a handle on your budgeting skills and are hell bent on success.     

You are a pumped up unstoppable monster of a debt killer.   Now get out there and kill the damn thing!  Get that side gig,  cut that spending, check the balance daily pay it down, pay it down.   Enlist your spouse in the quest.  Eat on less than $3 per day.  Cancel the cable.  Get a Republic phone,  earn 4K per year churning checking accounts (doctorofcredit.com)  churn some credit cards rewards,   pick up cans,  drink only water.   

Your hair is on fire!!

[thd7t]

Not a big proponent of emergency funds.    If you have credit cards those cover your so called emergency.   I think E funds are really more appropriately called contingency funds,  fun funds or zero interest funds.   

Here is the reason I don't like them.

You have 3K setting there earning zero.    Take that 3K and invest it for 60 years.  (yeah,  I know, probably only your kids or grandkids would benefit right?)

In 60 years you will have 500K in inflation adjusted money and your kids will think very highly of you.   Let it sit in an E fund and you will have $500.   Ask your kids if they would rather have 500K or 500. 

In 60 years, you'd need an 8.5% real return, which is a pretty big projection, even in my optimistic view!  I'd argue that a real emergency is harder to deal with if you don't have cash, because of cascading events.  For example, you work in building development (because I am in a related field and I believe that you were also), and there is a substantial market downturn like 2008.  Jobs in building became less common.  Simultaneously, homes lost value, which would reduce/eliminate people's available HELOC room (I know you didn't mention HELOCs, but MMM espouses them as an e-fund) and credit availability is reduced.  Credit cards can easily cut the amount of credit they extend with minimal notice.  This happened recently and while I'm not saying that it will happen again, an emergency fund provides real security in a way that lines of credit do not.

[Deimyts]

Thanks for the prudent advice, everyone. I will be patient!

Do the math -- On a sum of $3000, 3 months interest at an an annual 9.5% is about seventy bucks or so, right? Is seventy bucks worth the risk of wishing your emergency fund was there between now and when you would be in a postiion to replenish it?

Very good point! I hadn't actually calculated the dollar amount it would save, or considered it in context of the rest of the debt—I was just looking at how much faster this particular loan will go to zero, and how nice that will feel.

I would check out SoFi to see about refinancing that stuff.

I've looked into refinancing before, but I haven't heard of SoFi. Thanks for the tip, their rates actually look pretty good, compared to the other options I've seen. The higher rate loan I don't want to refinance at this point, because the balance is so low already, and because it has some built in security - since I've been overpaying on it for so long, in the event of an emergency, I won't be penalized for missing a payment until something like 2020. Not that I plan to, but it is nice to have that option (and I've used it before, in worse circumstances).

Not a big proponent of emergency funds.  If you have credit cards those cover your so called emergency. I think E funds are really more appropriately called contingency funds,  fun funds or zero interest funds.

I have to disagree with you there, too. You're right about the math, even if your return projections are a little high (and even at 8.5% over 60 years, I still get a higher return paying off my 9.5% loan!), but i am content to sacrifice that money for the security of liquidity. I can see using credit cards as a solution for one-time emergencies, if you have an otherwise steady income, but I tend to look at my emergency fund as "What if I lose my job?" money. And if I'm going to be unemployed or making only sporadic income for an unknown period of time, I'd rather not be racking up credit card debt before I know where the money will come from to pay it back.

 It's not just hypothetical, either—we used up our last emergency fund in exactly that situation, before I got my current job. I'm really just being wishy-washy about it now because I perceive my current job as more secure, and because of the impatient desire for the sense of achievement I'll feel when this particular loan is finally paid off. But, as all the replies in this thread will attest, those are probably not good enough reasons to get rid of the fund.

Plus, after the loans are paid, we intend to keep saving at about the same rate, or higher. Yes, we'll have sacrificed (a probably large) amount of money (in 60 years time) due to the delay caused by servicing the debt, but making as much money as possible in my lifetime isn't my ambition—if it was, I probably wouldn't be on this forum.

[Fuzz]

I'm in a similar situation. I am not a big believer in the e-fund. I settled on $3K in a savings account as an e-fund. But if my job was really secure, I could see going below that. Also, I think you should pick a number, and when you hit that, start investing some money in addition to paying off debt. At $36K in student loans at 6.55 percent interest, your total interest payment is $2500, which is the max student loan interest deduction. So for me, once I get to $36K, I am going to invest more and pay down debt more slowly. But that's a choice that can be argued both ways. I'd read the wikipedia on sequencing risk, or some of arebelspy's stuff. The argument that you should invest vs save, depending on whether your interest rate is higher than your expected rate of return is pretty nuanced.

tldr: might not make a difference.

[Deimyts]

I'm in a similar situation. I am not a big believer in the e-fund. I settled on $3K in a savings account as an e-fund. But if my job was really secure, I could see going below that. Also, I think you should pick a number, and when you hit that, start investing some money in addition to paying off debt. At $36K in student loans at 6.55 percent interest, your total interest payment is $2500, which is the max student loan interest deduction. So for me, once I get to $36K, I am going to invest more and pay down debt more slowly. But that's a choice that can be argued both ways. I'd read the wikipedia on sequencing risk, or some of arebelspy's stuff. The argument that you should invest vs save, depending on whether your interest rate is higher than your expected rate of return is pretty nuanced.

I figure you can use a bit of fuzzy math since the return from paying off debt is constant and guaranteed, while investment returns are highly variable. The way I see it, if the interest rate on (fixed-interest) debt is less than the average rate of inflation, I'm probably better off investing, but if it's higher, the additional peace of mind from being debt-free adds enough value to debt repayment to make it a priority, even after the interest rate drops below average index fund returns.

Plus, most of my debt is at about 5-6%, and while I could possibly make higher returns in the stock market, it's a pretty close call, with a lot of additional risk. Even at a 4% rate on the loans, I would be hesitant.