Emergency Fund Exception?
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  1. #1
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    Default Emergency Fund Exception?

    Hi there...my wife and I are literally just starting the seven steps (we just shut down our 401k even with our employer offering to give 3% for our 6%...gulp). We have no credit cards but are a couple years out of college with $118,00 in student debt. Combined income $100,000. Also have childcare expenses for our newborn since family is all so far away. Cars are both old ('94 with 235k miles; '97 with 150k miles) but paid off, thankfully. Looking like with our current income/expenses, we have a challenging, but good goal, of paying it all off within 6-7 years. Since it will likely take that long to get rid of these loans, it is highly probable that our cars will not still be pushing through by that point. I am not sure the $1,000 emergency fund would be enough to get us a reliable car when one of our current cars die for good. Am I right in thinking this? How much should we put aside before attacking the loans?? Thank you!!

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    If you're following Dave's plan to the letter, then he spells out the steps pretty clearly.

    If you're asking for advice on how to NOT do Dave's plan, then my first suggestion is to continue adding to the 401k, because you're giving up an immediate return of 3%. Student loans are typically low-interest, which can be written off on income taxes. As for the emergency fund, I would either keep the $1000, paying extra towards the student loans, until a car breaks down. Then I would pay the minimum on the student loans until I pay off whatever vehicle was the replacement. The other option is to save up what you feel you would spend on a new car, and then pay extra on the student loans.

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    Thanks for the comment. For clarification, we are trying to follow his plan to the letter. However, while his general first step says to save emergency fund of $1000 before attacking debt, I listened to a podcast of his where he spoke to a woman whose car was near the end of its life. He agreed that in this situation she should put aside more than $1,000. I'm just now sure how much more.

    While our interest rates are fairly low, we have enough loans that the minimum payments (summing to near $800/month) only pays approximately $250 in principle each month. So pulling our 401k investment as he advises will allow us to attack an additional $600 (from 401k alone) in principle.

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    Jeter, what is your shelter situation - renting or buying? If buying, what are the terms - mortgage, rate, length?

    Keep in mind, the DR Plans are for becoming 'debt free', not for 'wealth building'. In general each of us is given about 30 yrs for wealth building, then we transition into wealth preservation, ie, lower risk things such as savings accounts, CDs, bonds. Wealth preservation products are designed to offset inflation, not out-pace inflation. That means that most of your growth occurs in that 30 yr wealth building block.

    So - it is important to direct your income stream to it's highest and best use. Eg, the $9000/yr that was going into your 401k would be about $2,000,000 in 30 yrs (using the generic US stock index average of 11%/y). But if you start 7 years late, it will be $910,000 - ie, there is always a cost when you re-direct your income stream (it's a finite stream, if you prepay a loan that money is taken from something else.

    (BTW, we share a birthday. )

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    It's a great birthday to have!

    We are on a 30-year fixed FHA loan (3.5%).

    I get the math and I guess that's the "gulp" in my original post. It seems like we have to choose between a) having a solid 401k by investing now and not waiting and b) paying off debt quickly. Some of our loans say we will not have them paid off for 50 years. I can't hardly stomach that. And following Dave's plan, we are wanting to invest 15% vs the 6% we were doing once we have paid off our debt. Looking at the numbers, while we will have to put more in for starting later, we will actually get a little more than the $2 Million back if we were to keep at 6% all the way.

    Really feeling the reality of "the borrower is slave to the lender."

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    Dave also says that you have to have your basic needs covered before doing the debt snowball plan. Transportation is one of those basic needs. I would consider saving a few thousand $$ myself to make sure that you have transportation needs covered (ie another used car purchase or car repairs) then putting your money toward the student loans. I am talking maybe an extra $2K or $3K for a really cheap used car replacement - not going out and spending $25K for another car. It might delay your debt repayment plan by 3-6 months, but saves you from incurring more debt if you need to buy another used car soon. The whole point being that you shouldn't be digging your hole deeper and taking out any more loans - not ever- no matter what!!! First and foremost is living within your means, then you can start to tackle the debt issues facing you.

    As far as the retirement plan, putting it on hold might give you a little incentive to hurry that debt repayment a bit more! Really look at that budget and slash, slash, slash .... I bet if you really got conservative on your spending then you could repay those loans in 4 years instead of 6 or 7.... Once your debt is gone then you can always put more than the 15% into your retirement plan if you want.

    In my opinion Dave's Plan is a great place to start, but the most important thing is to learn during the process how to live below you income, stay debt free, and save for the future (both for short and long term goals). Sometimes the plan needs a little minor adjustment for it to work for some folks.... Depending on your situation a $1000 starter Efund may not be enough. Some people may even want to keep the 401(k) going. (I did because I got a 100% match for the first 3% I put in.)

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    Thanks for the thoughts...I think you're right in saying that "putting it on hold might give you a little incentive to hurry that debt repayment a bit more!" Leaning toward saving $3k then getting the ball rolling. 6 to 7 years seems like a dream right now so 4 seems crazy, but it could happen. Will be tough but worth it. Thanks again.

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    Really feeling the reality of "the borrower is slave to the lender."
    Good job on the 30y FR 3.5% loan, that's a 'keeper'.
    Here's a math example, I used this several times in my 40 yrs as a landlord, owner of 4 Single Family houses.
    Refi a house and borrow an extra $50k. The $50k at 5%, 30 yrs costs an extra $268/m ( $97k total). Place the $50k into an 11%/y index fund, grows to $1,150,000 in 30y. We did this several times, whenever the equity built up in one of our houses, and whenever rates were attractive.

    As for paying an extra $47,000 in interest for the use of the $50k for 30y - I have no problem with that, I stayed focused on the real goal, ie the $1,000,000 - and felt that the $47k was money well spent.

    I don't know the terms on your SL loan - but approach that you might consider, after the house has built up another $100k of equity, refi and take out enough equity to pay off a higher interest, shortterm loan. Anytime that you can convert your shortterm needs into "long, low" capital, and put that capital to work elsewhere, you can build wealth.

    Cars. We have financed them 100% since about 1985 (in 1985 we paid cash for a new car cuz the rates were about 15% or 16%.) When we get a car, I have 2 choices
    (1) Sell about $33k from our Taxable SP500 Fund, pay $3000 cap gains tax on the profit, pay $30k cash for a new car.
    (2) Leave that $33k in the Fund (on average it will double to $66k in 6 1/2 yrs (rule of 72). And finance the entire car, tags, tax - a total of about $34k in payments over 60 months.
    Again, I have no problem with paying about $4000 for the use of that money, instead I focus on the $66k growing in our Fund.
    As I said, I like to put my our income stream to its highest and best use.

    we will not have them paid off for 50 years. I can't hardly stomach that.
    But that's emotion, not math. I had multiple mortgages on our rental houses for over 40 yrs - I got past that wish to prepay them, lol. I still had a loan on the last rental when I sold it last yr.

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    Thanks, old guy. Some really good points. I will be thinking and praying about this more before making a final decision.

    While I'll admit that emotion does play into my thought process some, personal conviction is more my motive than emotion.

    Thanks again!

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    Old guy, thinking about your comments...looking at my loans here (upon second look...we do have a target and tj maxx card that we used but don't plan on using again), with given interest rates, would you still suggest paying the minimums even though it may take 50 years on some of the loans? And instead invest in 401k? Her Fed loans will begin in October by the way. Couldn't figure out if I can attach a file on here or not, so I know this won't be the easiest to read.

    Balance as of: 7/15/2016 CONTINUED 7/15/2016
    My Fed Loans Total Due My Perkins 1
    3.86% $1,405.75 5.00% $410.91
    3.40% $2,860.62 My Perkins 2
    6.80% $4,039.86 5.00% $1,332.57
    3.40% $4,680.98 My Perkins 3
    6.80% $2,393.51 5.00% $11,931.79
    6.80% $4,787.02 Wells Fargo Private
    3.40% $5,431.97 7.99% $4,541.83
    6.80% $2,538.67 12.25% $5,487.20
    6.80% $8,682.83 Target
    6.80% $7,387.60 Unsure interest $662.88
    Her Fed Loans TJ Maxx
    4.50% $3,517.42 Unsure interest $203.00
    6.80% $10,324.65 Hospital
    6.80% $5,581.13 No interest $1,000.00
    3.40% $8,101.10
    6.80% $5,309.06
    6.80% $2,556.61 TOTAL $761.17 in Minimum payments $118,501.77
    3.86% $5,627.52
    3.86% $7,705.29

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    And instead invest in 401k?
    One way to judge if prepay is a good plan - ask what would you do if your had $118,500 in the bank?
    (1) Spend it to Prepay and then direct that $761/m to invest at 11%/yr for 31 y. That is $2,250,000.
    (2) Or, Invest the $118,500 at 11% and direct the $761/m to the loans. That is $3,011,000. (Plus there is the free money from the 'match'.)

    In both cases, the cash-flow requirement is $761/m - and in both cases the money is invested in the same 11% fund (same risk level). $761,000 difference.

    In general, the sooner that you get a lump of money placed at 11% (rather than spending it on prepays) the sooner it grows. In practice most of us have to invest incrementally as we earn it - but when there's a choice, get the money working early. In our case, my 401k grew to about a million at retirement - that was incremental. And whenever we refi'd a house, that lump sum was invested. That, too, grew to a sizable amount.

    BTW, If all your loans were at 6.8%, your loan term would be 31 y. (it would just seem like 50y, lol)

    I never prepay 3.4%, 3.86%, 4.5% loans - those are all 'keepers'. Long ago when mortgages were much higher, I have purposely put new 7% mortgages on paid-for rental houses and invested that equity. But at that time, the SP500 Index was paying about 15%, so my differential was 8%, similar to today's delta of 11%-4%. But today, I wouldn't borrow investment money at 6.8% to, I would stay under 6%.

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    well to clarify daveR. $1000. Is the BEF (baby ememrgency fund) that is for unexpected incidentals like a flat tire,leaky toilet,a small medical bill so you dont add to your CC debt.
    Now the Emergency fund is later. That is for 3-6 months of living expenses in case of layoffs,illness and other larger events-that comes after debt payoff.
    Dave says to drive beaters,which you are. And he woud advocate a side fund or envelope to start funding that expense that will hit in the near future from which you would by another beather for now. (beater is defined as an older but well maintained vehicle not anything dangerous for the baby obviously.).

    Just type D.R. baby steps and it should come up to explain on the internet. We took the course and loved it. Helped us immensly.

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    Old man, when you put it that way, it definitely seems like option 2 is much better...it just takes patience. Even though having the debts paid off early would likely give an invaluable peace.

    My question is how do you know those are 31 year loans? My student loans began on a 25 year repayment plan and I had to ask them to drop the monthly payment amount because we couldn't afford $1300/month total that the 25 years plan called for. They dropped them all and that's how we got right under $800. And that's why I think some of the loans are set to be paid off in 40 years while a couple said 50. I guess I'm trying to understand how you can see the interest rate and know when I'll have them paid off if I do the monthly minimum.

    Really appreciate your time by the way. Great learning process for me.

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    Thanks Warrior. This is the clarification I was initially looking for! So he is okay with us saving the initial $1k, then attacking loans while pocketing $200/month or so for the eventual breakdown of cars. Thank you! Although old man now has me reconsidering the whole thing. Ha!

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    I always still contributed to the 401K when we had matching. Thats free money. Even if your investments arent paying off. I would suggest you still contribute up to that point of 3% matching even before you drop those of the higher interest loans. Then get rid of those 1st. A lot of us do a modified DR. His set up this way is for those w/o any budget awareness who are going down w/ the CC debt ship.

    My "kids" are your age and I always taught them that debt is like maple syrup. Tastes good at first but if you get it all over you things cans get kind of sticky. And then everything becomes about cleaning it off. D.R. also teaches that education is the better of the debt because it is an investment in youself and your future. He also recommends dumping it ASAP.

    So yes,that sounds great as a plan. initial $1000. then paying down debt while supporting "4 walls". Then I would target the smaller loans while investing the 3% match. Just keep blasting chips off these things then move to the next,then the next.
    W /in the time keep having small amts of fun so that you dont get burnt out. We did free events,dinners at friends-taking turns,investments in state of park passes,ice cream sundae and game nights. What ever will be fun for cheap for a short time as things "loosen up". A change of scenery can do miracles. We used to take stroller walks looking at neighbors house and say what we would do if we owned that house. Just a game but it occupied us freely.
    So sounds like your getting some advice and taking it in. I would suggest trying coupons if you dont already. I used to super coupon when the kids were teens and Ds was consuming food like a locust. I dont need to now then hes "left the nest" but we still use oil change one,hair cuts for Dh and supermarket mail to us based on our habits-coupons. W/ consumerism think of it as a tug of war. They want your money,you want their stuff. Win when you can by less impulse buying,shopping the internet to compare and using any discount available incl. things like insisting your food is right at a restaurant,asking for money off on damaged goods,and using the phone for codes w/ the goal of using it for free by using it to get deal and discounts. Mines a cheapy at $34,31 a month (AARP) and I keep in mind thats what I need to "earn" to keep it. So personally I keep store cards for discounts. Kroger alone gets me points for .50 off a gallon of gas. So prob. $10. a month savings for me and the same for DH. We run everything thru the CC paying off balnces 2-3X a month and making around $25. a month in points and credit to pay for stuff we need like groc. (circling back to points that earn points). We get our gas,grac, and meds at Kroger.

    Anyway enough gabbing. Good luck and congrats for being mature enough to hand;e debt and not letting it handle you.

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