I don’t have quite enough in savings to get out of credit card debt, completely, but as I continue to accumulate money in my emergency fund I’ve started wondering if it makes sense to use some of that cash to pay off debt. It’s a classic financial dilemma: continue to build emergency fund, or pay off debt?
If I used all of our available savings we would be almost back to zero, and would need to use a credit card if a large emergency came up before we could rebuild the emergency fund. That scenario reminds me of the hamster wheel of debt that got us here in the first place!
Interest Rates Matter, Some
The argument for using savings to pay off debt is made easier in this environment of low interest rates. Sure, interest rates on my credit card accounts have dropped, but are still significantly higher than any rates I’m able to lock in on savings. Just last week ING Direct lowered the interest rate on our Orange Savings Account to 2.75 APY. That is still much higher than the rate earned on my local emergency fund, but several percentage points lower than the interest I am paying on revolving debt. However, since I am not overly concerned with the interest earned on emergency savings–it is just for emergencies, not investing–it is hard to justify cleaning out my emergency fund to pay off my debts.
The Psychological Benefits of Having Savings
Often times people do have significantly more in savings than they owe, but are still hesitant to pull the trigger and become debt free. That’s where the psychology of money comes into play. When you know several thousand dollars are sitting in an emergency fund ready and waiting to tackle your family’s next big emergency, it is a comforting feeling. Draining that fund down to zero, or close to zero, immediately brings out pessimistic thinking. What if the roof starts to leak? What if the car dies? What if I get horribly sick and miss several weeks of work? These are legitimate concerns. After all, those are the very events we hope to avoid, but are prepared for with a solid emergency fund. Without that cushion it feels like we are living life too close to the edge.
Bottom Line, We’ll Probably Use Some Savings to Pay Down Debt
Even though we don’t have enough in savings to completely clear our debt, we have enough to make a significant dent. However, with an ongoing medical emergency in the family, I am reluctant to use the majority of these savings for debt repayment. What we will do is use about $1,000 to finish off an old consolidation loan that’s been hanging around since I finished school. The loan has a large monthly payment, and by using that $1,000 to clear it I’ll be able to put a couple hundred dollars a month towards something else rather than continuing monthly payments for the next three or four months until the loan balance finally reaches zero. Since we have beefed up our emergency fund a bit, we can do this without dropping the emergency fund down below our comfort level. Admittedly, the thought of knocking out yet another debt is exciting! One step closer to debt freedom!