This was my dilemma a few months ago. I had a loan (well actually a few) and a tiny little emergency fund called my Never Go Back to Fresno fund. I was slowly adding to my little savings account because I kept reading everywhere that you needed to have an emergency fund and have some kind of savings. Since I am a dirt poor student, working for minimum wage right now I was only able to put in about $2-$5 a month into my savings but I was really proud of doing so after paying all of the monthly bills.
Then I sat and thought about one of the bills that I was paying. The interest rate on the loan was over 10% while my savings account was earning 4.5%. The amount of money that I had in the savings account was less than half of the balance on the loan so what was I really doing? I decided to raid the savings account and use all that money to kill off the loan.
This strategy was part of my debt snowball to reduce all the debt that I have. Now I have no savings account….but I also have one less loan. I think that some people thought I was crazy to raid the savings account to pay off the loan ahead of schedule but in the end I think it makes more sense. The amount of money that I would have been getting in interest on the savings account would be a lot less than the amount I would be paying in interest if I had continued to pay the loan according to the schedule set out by the bank.
What do you think of my strategy and what would you have done if you were in this position? Comments are open and I welcome your input.
I think you may have made a bit of a mistake there, to tell the truth. Being an international student, you are limited on where you can work, aren’t you? So it stands to reason that you would want a larger emergency fund in case of unemployment. If your job situation was excessively stable, I could understand doing what you did. But as it stands, I think I would suggest keeping the e-fund high until you are out of school or on a different visa.
But that’s just my opinion.
I see what you are saying Jagular. The thing was that I did not have much money in the savings account anyway so the interest I was getting was not even coming close to the interest that was piling up on the loan (which is for a car I no longer have by the way).
Using the money from the savings to pay the loan put me at a zero-ish position because I would still have to be using credit for things that came up anyway. I am trying to build back my efund now but I still need to focus on the fact that I have credit cards with rates up to 20% that need to be paid off since I can only get 5% interest in online savings accounts.
Hello Lulu,
Just came over by way of a comment that you made on
“My 2 dollars” site.
I think I would have get the savings as it is important that you have something to fall back on in case of rainy days.
You would feel more secure, more relaxed and feel like you have a little “something” that has value.
So,in order to help you re-start your saving account, I just paypaled you a little something.
Hope it will be the beginning of your “road to riches”.
Marie
Thank you for the donation. I am going into PayPal now to send that donation over to the savings account…which now stands at $10.
Thank you so much…what a lovely early birthday gift. 🙂
I think you did the smartest possible thing. Now you can put the money you would have used for the loan back into savings, making it grow that much more faster.
I don’t understand why others can’t see the logic in that. It’s not as if you took a huge nest egg. . the numbers you cite make your decision the obvious choice.
Hey Wanda,
Thanks for visiting. I feel comfortable with the decision that I made at the time based on the amount of money and the interest rates.
I did a little article about this involving the returns on paying off a credit card vs. having it sit in a savings account.
You can read it here:
I am also subscribing to this blog, since the more finance blogs I can read the better my blog will be.
Thank you Mark. So I am guessing you agree that I made the correct choice by paying off that loan.
Yes, depending on the type of loan and the return you’re earning. Simple math says that you are paying a negative 5.5% by not paying off the loan, the reality is that you are hurting a lot more since you have taxes on interest income.
I would say set aside a little bit of money for emergencies ($400 or so if you’re in school) but no more until the larger interest debts are paid off.
Once out of school, then $1000 is a more appropriate number because it’s generally harder to cut expenses like you can in college.
How about this:
Lately I have switched a ?4000 loan over to a credit card with 0%. Sure I have to pay a transfer fee of 2% but then I get nil interest for 12 months. I then get 6% interest on my savings and pay no interest on my loan. All I have to do is keep up the credit card payments and switch every year to another 0% credit card.
Saves me money and has helped get me out of debt much quicker.
My Debt Advice Website