Saving money while still in debt may seem like a silly idea. Why not put that money towards debt and lower your money paid to interest? But on my journey to debt-free living, I’ve found that almost everyone suggests setting up an emergency fund—even if you’re in a lot of debt.
The logic is that if you are unlucky enough to be laid off, have an accident or fall victim to a natural disaster, you spend your money and not a credit card, line of credit or anything else that will charge you interest. Instead of paying $800+19% interest/month to get your car fixed, you’re just paying $800.
At first, I was tempted to put $1000 into my credit card debt instead of setting up an emergency fund. But the more I read about other people’s debt, the more I realized that many of these people started out in a little bit of debt like me. But then they found themselves without a job or had a medical emergency. They didn’t have an income or an emergency fund to pay for living expenses. Instead of being in $20,000 of debt, they soon found themselves with a mountain of $100,000 or more debt to pay off.
I didn’t want fall into that trap so I deposited my tax return into a high-interest savings account at my bank. I know it’s not much and I admit I’m having difficulty following my budget these days, but It’s comforting to know that there’s money in the bank in case of emergency.
Lesson learned: No matter what, have an emergency fund for those unpredictable situations. You never know what will happen.
4 comments
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August 12, 2008 at 8:41 am
Tim Ramsey
I recently came accross your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog.
Tim Ramsey
August 19, 2008 at 12:06 am
DAvid
“Medical Emergency”? You live in Toronto, Ontario, right? The medical emergencies that occur south of the border can not and do not happen here in Canada due to the socialized medical system of which we are so justly proud. It has protected many residents of Canada from financial disaster, due to unexpected medical bills. If you want an emergency cash fund to cover unexpected expenditures, then create one, however, you might be better whittling down your debt, and borrowing it back for those times when you so desperately need it, rather than having savings for eventualities you never experience. Putting your money into a savings account, just means your income is being eroded at a faster rate than if you reduced debt.
Look at it this way, if you put money in savings, you have higher minimum payments on your debt than if you paid it off. If a financial emergency occurs, you are now depleting your savings to cover the higher minimum payments, so are you really further ahead? What if you never have that financial emergency? You have paid an ‘insurance premium’ of the difference in interest.
My suggestion is to manage your debt so that you are paying it faster than the minimum amounts, so you can recall that money if needed, and in the meantime you are paying a lower cost in interest charges. For example, if you make extra payments on your mortgage, you can withdraw that same amount back from your mortgage, in addition to having a payment holiday of one month. All the while you are sitting on your reduced mortgage, you pay a smaller amount in interest, but the money is still there should you need it. Let’s say you put the $800 against you debt instead of savings account. The $800 works month after month saving your ’19%’ interest each and every month. Should you need the $800 back, you can use your credit again! In your high interest savings account you get about 1.5% interest. That’s 17.5% you threw away.
You may find you have fewer ‘emergencies’, as you manage your cash flow in a more responsible manner, as your savings are not so visible to you, and are a bit more difficult to access.
BTW, why are you carrying high interest credit card debt anyway? You should be able to obtain a lower interest card, or other loan to convert it to a lower cost debt, then pay it off faster.
DAvid
August 21, 2008 at 5:07 pm
andreachiu
Thanks for the comment David. You’ve certainly given me something to think about and I really value your advice.
You’re right about our health care, so it’s not my main concern. My primary reason for keeping an emergency fund is to protect myself in case of unemployment. I’ve gone from one contract to another in the past two years and while I’ve been steadily employed, there’s always a chance I could be without work for a month or two.
Knowing that, do you still think I should pay down my debt instead?
August 21, 2008 at 10:37 pm
DAvid
andreachiu,
Can you collect EI between contracts? If not, then you may wish to have some months of expenditures available to you. This might include paying your debt and being able to re-draw it, or having some investments to cash if necessary. You have to do what is comfortable for you as well, as you have to sleep at night.
You might, for instance, pay your credit cards out with a Line of Credit to get a lower interest rate. You could then either pay the LOC at the same dollar amount as you did the credit cards, paying it down quickly, but being able to withdraw from it if necessary, OR, you could pay the LOC at the same rate as the credit cards (having the LOC paid of in the same timeline as the credit cards), and put the difference into your savings.
DAvid