Author Topic: How big of an emergency is this debt? (aka the "what do I do now" question)  (Read 2356 times)

newgirl

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Ok so last month I cashed in my savings to retire a truly ridiculous credit card debt. Upside is that I have no more credit card debt! No more throwing away thousands of dollars a year on interest.

The bad news is that I also have no savings. I have started using YNAB and have a positive cash flow, but not enough history yet to really get a sense of what typical spending is for me.

I have a single, consolidated federal student loan. Current principal + accrued interest is 35,879 with an interest rate of 4.875%. This is my only current debt. Incidentally, I now make too much money to qualify for the student loan interest tax deduction.

Do I rebuild savings or pay more towards the loan? I was paying $500/month in credit card payments, so that amount can go towards either savings or the loan (or both, I suppose), with no other changes to my monthly budget. I plan on using YNAB to identify and plug further holes, I've used it in the past and liked it a lot. But for the purposes of this question assume I have $500/month to play with.

Having no cash savings is an uncomfortable position for me, and for whatever psychological reason I like having 10k+ in the bank in order to feel secure. That's why it took me so long to just huck it all at the credit card, which was dumb thinking that cost me a lot of money over the last 2 years. I'd prefer to be less dumb going forward...

MustachioedPistachio

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Do you still have the credit card(s)? Those could serve as a temporary e-fund. I take it the reasons for having a credit card balance have been addressed?

What are your other cash flow obligations? Anything that could be cut to free up more space? How "risky" is your current cash flow? I.e. own a beater car that could give up the ghost on your un-bikeable, un-bus-able commute any day now, old home with iffy guts, kids, health-related stuff, caring for family, are a sampling of scenarios that could throw you down to the riskier end of the spectrum. The riskier the position, the more cash you should have on hand until your position ameliorates.

Own a home? Have a HELOC?

Otherwise, save up around 3 months worth of living expenses then start paying down the student loan and/or investing.

newgirl

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Do you still have the credit card(s)? Those could serve as a temporary e-fund. I take it the reasons for having a credit card balance have been addressed?

I do have the credit cards on ice in the freezer, hah. Total credit line around $20k. The reasons for having such a LARGE balance have been addressed (i.e. debt incurred during my divorce), but I'm still working with YNAB to make sure my monthly cash flow is positive. I believe it is but will need a few months with YNAB to really identify where the spending can be improved. I've already cranked way back on discretionary stuff (most of which is buying stuff for my kid that she doesn't really need). I don't eat out much but suspect the grocery budget could be better. Once I have a month of data in YNAB it will show the brutal truth but to be honest at this stage I don't have a good sense for what our cash flow has been.

What are your other cash flow obligations? Anything that could be cut to free up more space? How "risky" is your current cash flow? I.e. own a beater car that could give up the ghost on your un-bikeable, un-bus-able commute any day now, old home with iffy guts, kids, health-related stuff, caring for family, are a sampling of scenarios that could throw you down to the riskier end of the spectrum. The riskier the position, the more cash you should have on hand until your position ameliorates.

Fortunately we are pretty stable. Jobs are high paying and in no danger, we have a kid but that's about it. I bus to work and we bike as a family to errands, so we wouldn't die if we were out a car. Partner works remotely even though his office is across the street. Medical emergency is always a possibility but we have good insurance (health, disability, etc). I'm not too worried about stability over the near short term. But yes I'm absolutely sure there are discretionary things to cut. Just not exactly sure how much or where.

Own a home? Have a HELOC?

Rent. Have talked about buying but partner doesn't have any particular desire to own a home.

Otherwise, save up around 3 months worth of living expenses then start paying down the student loan and/or investing.

Thanks. That's probably more reasonable than my 5 figure emergency fund...


Dave1442397

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If you increase your student loan payment, call the company first to make sure that the extra money will be applied to the principal, and not the interest. A lot of lenders will not apply the extra money to the principal unless you specifically direct them to do so.

NeonPegasus

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You should absolutely put together an emergency fund of at least 3 months before putting extra towards the student loan. You don't want to get forced to put money back on credit cards in case of an emergency. Remember, you can't get back extra money paid toward the student loan so it doesn't matter if you've paid half of it off - you will still have to continue making the same monthly payments. It's better to have a cushion of cash to get you by.

Raenia

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Build up a small emergency fund first (3 months is a good place to start).  After that there are a few things to consider.  Does your job give you access to a 401k?  Is there matching?  If so, that's worth doing before paying extra on the loan.  I recommend following the Investment Order by MDM.

Quote
WHAT           
0. Establish an emergency fund to your satisfaction           
1. Contribute to your 401k up to any company match           
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.           
3. Max HSA             
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level           
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)           
6. Fund a mega backdoor Roth if applicable.         
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.           
8. Invest in a taxable account with any extra.           
           
WHY           
0. Give yourself at least enough buffer to avoid worries about bouncing checks           
1. Company match rates are likely the highest percent return you can get on your money           
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
    At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 25%; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise. 
   See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
   See Traditional versus Roth - Bogleheads for even more details and exceptions.  State tax (or lack thereof) should also be considered.
   The 'Calculations' tab in the Case Study Spreadsheet can show marginal rates for savings or withdrawals*.
5. See #4 for choice of traditional or Roth for 401k.  In a 401k there are no income-based limits for deductions or contributions.     
6. Applicability depends on the rules for the specific 401k           
7. Again, take the risk-free return if high enough.  Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
   (e.g., target retirement date) that provides a blend of stock and bond returns.  If you wish to consider separate bond funds, compare the yield on a fund
   with a duration similar to the time remaining on the loan, and put your money toward the one with the higher interest/yield.
8. Because any earnings, even if taxed, will help your FI journey.

Proud Foot

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Since you are just starting to track your expenditures I would suggest to take a few months to figure out your normal expenses saving what is left over. This will get you a start on rebuilding the emergency fund and allow you to get a better read on your expenses. After that follow the Investment Order posted by Raenia (from the Investment Order thread by MDM). With your interest rate you could put it anywhere between #2 and #7 based upon your comfort level. At 4.875% I personally would put it at #2.

newgirl

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Thanks so much everyone. The order of investments makes perfect sense, I found the original thread which was really helpful in understanding how to prioritize.

Plan is to build cash savings of 3 months expenses (which I will have a better idea of what those are after YNAB-ing). I'm also getting a corporate credit card from work since those expenses always seem to put me in a cash flow crunch, even though I get reimbursed eventually. So I just won't carry any of those expenses myself anymore. I got paid today and budgeted out income for the next two weeks, due to aforementioned work expenses it will be a little tight (several nights hotel stay expenses take out a pretty good chunk of the money that would otherwise be available) but I can make it work without putting anything on the card and still paying everything that will come due. The first part of the month is always tighter than the last just because of bill due dates.

To the person who asked, I do have a 401k at work with an employer match, and I do already contribute enough to get the full match, plus it's set up to do the 1% auto increase every year. I'm going to keep doing that and then take a more holistic look at student loan vs. investment vs. further short term saving once I have a handle on my cash flow and my e-fund rebuilt.

newgirl

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If you increase your student loan payment, call the company first to make sure that the extra money will be applied to the principal, and not the interest. A lot of lenders will not apply the extra money to the principal unless you specifically direct them to do so.

Yes, mine doesn't apply extra to the principal - thanks for the reminder to square that away with them before ramping up repayment.

LadyMaWhiskers

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I guess this will be a bit contrarian, but I'd suggest you save $1000 then live as lean as possible and lay off the student loan aggressively. This will remind some readers of Dave Ramsey (which it is.) You sat on the CC and now you're getting ready to sit on the student loan. Throw cash at the thing! Every dollar you can get your hands on, and get it out of your life!

Roe

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What kind of emergencies are likely to occur in your life, and what would they cost?

We have 0 in emergency fund, and feel very confident in that decision. If the car breaks down we wait until we have money for a new one. If we loose our jobs we will survive on the unemployment pay. While waiting for that to kick in we can easily get by on one salary. If something truly unexpected comes up we have a choice between using credit cards, cashing in investments, help from family or expanding the mortgage. Depending on what makes most sense at the time.

Taking a similar inventory of your own life might put your mind at ease about not having an emergency fund, and instead gaining the decreased interest or increased investment income.