Should I Pay Off Debt With Savings?

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!


  1. I’m luck not to have any debt, so I don’t know what it’s like, but this strategy sounds pretty sound, especially if it frees up a couple hundred dollars a month for other uses. I can’t imagine not having an emergency fund now.

  2. You’re right on point by saying that it’s a psychological comfort knowing that you are sitting on a good emergency fund. Even though I’m not 100% debt free (yet!), I can breathe easier knowing that if something unexpected pops up, I’ll be able to handle it and the situation won’t stop my momentum for killing my debt.

  3. Tough question – you want to utilize your funds as efficiently as possible (ie pay down debt) but you want the safety of an emergency fund. Sounds like you have found a good balance.

  4. We’re only up to maybe 2.5 months of emergency money in the bank, so we definitely wouldn’t dig into it. However, my husband’s year-end bonus will likely be enough to pay off one of my student loans so we are debating doing that rather than saving the bonus, as it is “extra” income that wasn’t budgeted in. This would of course free up the payment to go towards other debt.

  5. Need to have an emergency fund but kill that debt. I am afraid that the markets will be flat for a few years at least so your best return from extra cash will be from debt reduction.

  6. Gotta say once ING reduced the interests rates about 6 months ago we took our money out and paid the balance of our remaining vehicle loan. Then we put the $ a month we were paying back on the loan into savings (and some to adding a payment each month off our mortgage principle). Seems stupid to be ‘saving’ at 3% yet paying interest on the loan at 6%. If you can afford to, I’d pay off the loans, or at least some of the loans. Maybe half the money instead and pay the loan quicker?

  7. FD,
    I retired my consumer debt (everything but my mortgage) some time ago and I did so by saving/investing the money until I got to the point where my savings matched my debt. I then paid off all of the debt.
    Retiring my student loan, consumer and vehicle debts allowed me to invest more money into stocks and real estate. I am now contemplating using the same strategy for my mortgage.
    Best of luck in whatever you decide works best for you and yours.
    – Tyler

  8. I think you’re making a wise choice. Each person has different needs for their emergency funds. You know that you have an ongoing medical need, so your fund would need to have more in it than mine.

    We were in a similar situation a couple of years ago. Our only debt was the mortgage, and our savings had grown enough to pay it off completely, though it would take us almost to zero. We have good health insurance, and it ended up taking an extra month to work out all the paperwork with the bank, so we didn’t dip as low as we might have.

    Once that monthly payment was gone, it went into savings and our emergency fund, and that built up quickly. In the last 18 months we’ve been able to keep that fund growing, as well as purchase a 2005 15 passenger van with cash, and pay for significant house renovations with cash as well.

    It is incredibly freeing to have money working for us, rather than the other way around!

  9. My wife and I recently did this about 2 months ago before the market took a poop (thankfully we did this then). We paid off 3/4 of our debt and to tell you the truth I would not have it any other way. We have much more b ack in our pocket from a day-to-day perspective and for us its worth it because it relieves a ton of mental weight in regards to debt. Yes, savings are great, but when you’re in the hole like we were we found getting out was better than not. Instead of behing up to our necks in debt, we’re only up to our calves now. Thankfully. 🙂

  10. We have a 6-month emergency fund in place, and our last debt is a car loan.

    Since six months’ worth of car payments are in that emergency fund, when we get down to the last $1600 or so that we owe on our car, I’ll take it from the E. fund since technically it won’t be needed there any more.

    Right now, I’m reluctant to pay it off any sooner since the economy sucks and we’re going to have a baby in a few months.

  11. There’s a thing called up-side, down-side analysis. It works best for things where the odds of having something happen are fairly well known.

    You take the possible reward times the probability of having that reward happen, and divide it by the possible risk multiplied by the probability of the risky thing happening. Then if the result is less than 1.0 you have a “bad risk”, whereas the higher the number is above zero, the better of a risk it becomes.

    So for a lottery ticket that costs $1 but has a 1:1,000,000 chance of winning $250…

    0.000,001 * 250
    —————– = 0.000,25 or 0.025%
    1.0 * 1

    … meaning you’d average one win for every 4,000 tickets you bought (spend $4,000 to win $250 and the odds of the $1 loss is 100% or certain).

    Now, suppose a person has $1000 in emergency fund savings, earning little to no interest, and has an opportunity to retire, say, a personal loan balance of $1000 at 6% interest. But if he does this, his only practical option in an emergency would be to use a credit card that charges 24% interest.

    1.00 * 6% * $1,000
    ——————- = 1/(4x)
    x * 24% * $1,000

    where x is the probability of having an emergency that costs about $1,000 before the cash cusion gets built back up again. Exactly what those odds are depend on how long it takes to rebuilt the cushion and how risky that person’s life is.

    A person who can rebuild the cash cushion in one pay period, whose job is stable, who doesn’t travel or own a car or a house, who has no pets, who is in good health, who has a pantry full of food, and who has access to free or low-cost medical care may be able to afford the risk easily since the risk exposure is low. Yet a person who will need a year to raise that $1,000, whose tip-based income is irregular, who has a clunker of a car that needs a lot of care, who lives in a fixer-upper house where something is always going wrong, who has dubious health care and a bunch of small kids, had better not take that risk.

  12. The money you were using each month to pay down the debt can be re-routed to your monthly contribution to the emergency fund, right?

    We often operate under the assumption that monthly line items in our budget continue to exist. I make this point every time people want to justify maintaining a newer car vs. keeping their existing vehicle. No monthly payment = $3-400/month you can stash toward the inevitable repairs. People work under the assumption that the monthly car payment still exists.

    All of you here with a used car have heard it, “oh, but what about this, and that… $200 here, $100 there, $500?!” I’ll take that instead of a monthly hit of $300 !

  13. I guess I would recommend keeping the savings account intact. You know how much your debt payments are. You know you’re not going to increase your balances. What you don’t know is what little (or big) emergency is waiting around the corner. So long as you’re able to hack away at your debt on a consistent basis, you have that cushion in case things go south. There’s nothing like having some cash available when you need it.

  14. Ever hear of Dave Ramsey ( He’s a financial advisor in Tennessee who has a syndicated talk radio show. He tells people to use the baby steps. Step 1: $1,000 mini emergency fund. Step 2: pay off all debt, smallest to largest, except for the house, as quickly as possible, gazelle intense. Step 3: finish the emergency fund of 3-6 months of expenses. There are 4 more steps but these are the biggest & hardest ones. You should check him out.

  15. Sounds like you have found the compromise that will work for you… pay off one loan, free up that monthly payment money, and still have the comfort zone of the emergency $$.

    When I was in that position before, I would ask myself…What is the worst possible scenario that could happen moneywise? and the answer to that would give me my course of action.

    In your scenario, if ALL the income were to cease, which way would you be better off cash-flow wise? For me, it would be to keep the emergency fund intact for that emergency that was happening, and pay the minimums on the credit card. If one pays off the card, the emergency $$ would not be there when the income ceased.

    However…. your compromise does the same thing. Plus will give you that extra cash flow 🙂 Great choice!

  16. I listened to Dave Ramsey’s podcast this morning and he told someone to use the $17K they have in savings to pay off 1/2 of the their debt. I would be very leery of cleaning out a healthy savings account to pay off my debt. If you use all your savings to pay off your credit cards and then have an emergency, you have to charge your cards back up again, this time with no savings. I’d ramp up my debt repayment but I sure wouldn’t clear out my savings. I think you’re going about it the right way.

  17. Don’t empty the emergency fund to pay down debt, or even to pay it off. Raiding it for a couple thousand might be worth it if it allows you to pay something off a month earlier, but keep some buffer and build it back up as quickly as possible.

    Why? Look at my experience. The month after we paid off the house, the air conditioner died. Then we had a broken tie rod on one of our cars. And then the hot water heater died. Three months, three big emergency expenses. Fortunately, I had built up enough in the emergency fund to cover all of it.

    I’m not saying it will happen to you. But the risk is paying off a few thousand dollars remaining on a 6% mortgage, but then getting stuck having to finance emergencies at 19% before you had a chance to build that fund back up. I don’t think it’s worth it.

  18. I’m with you. We’ll be taking some savings to pay something off when we get close. It will just give us more motivation. Great post!

  19. I am firmly in the savings first camp for the simple reason the more you have in the bank the less likely your are to spend!

    Secondly a large part of our recent problems were due to a lack of savings, when one has no savings one much use CC debt for emergencies!