I recently received a question about paying off student loans and saving. Here it is:
I recently graduated and moved to start a new job. I’m living rent-free for a couple months with my GF in order to save my first few paychecks but I’m not sure what to do with that saved money (1600-2000/month). I have appx 5,300 in debt that will start earning interest at about 6.25% in late May. My initial instinct is to put 100% of my savings towards paying that down, reaching a zero balance by late June. Yet, I’ve always been told that an emergency savings level of 3-months pay should one’s top priority when transitioning from full-time student to full-time worker, especially given the current economic conditions. What should I do? Should I mix my approach? 70-30? 50-50?
Confused in Houston
Should you pay off debt, or build your emergency fund?
Hi, Confused, this is a great question, and one that most new college grads face. The first thing I would do is set parameters with your girlfriend. “A couple months” is very broad and can mean different things to the both of you. I recommend having a clear understanding of how long you will be living rent free, and under what conditions (until the debt is paid off, longer than that, etc). I would also highly recommend chipping in by paying some or all of the utilities and groceries. A relationship is about sharing and compromise, and it is asking a lot for her to pay for everything while you are saving a lot of money.
Regarding paying down the debt or saving, there are a few ways you can go. You definitely want to reduce your debt as quickly as possible, but you also want to have an emergency fund in place. Dave Ramsey, a well-known money guru, recommends saving a $1,000 emergency fund, then paying off your debt as quickly as possible. I think this is good advice for your situation. Your debt is not overwhelming, and you should be able to pay it off very quickly. And the 6.25% interest rate is not very high, so taking an extra month or two to pay off your loan will not cost you very much money. After your debt is paid off, I would recommend continuing to build your emergency fund.
Pinyo @ Moolanomy
Before thinking about paying down debt or building an emergency fund, have you considered paying your fair share of rent? It really crossed me the wrong way when you said you’re living rent-free because your girlfriend is paying. If you can save $2,000 a month in in a high yield savings accounts or high interest checking accounts, you can at least help her with some expenses.
Now, let’s get to your question regarding paying down debt or starting an emergency fund. First, there’s no wrong way. If you are more conservative, you can follow Dave Ramsey’s Baby Steps, start a $1,000 emergency fund first, and then use Debt Snowball to pay down your $5,300 debt.
If you’re a little more aggressive, there’s nothing wrong with putting everything you can toward your debt. And instead of paying down your smallest debt first per Dave Ramsey’s method, try paying down your most expensive debt first (i.e., highest interest). After you’re debt is gone, then focus on building up 3 to 6 months worth of emergency fund.
I hope this helps. Good luck.
Plonkee @ Plonkee.com
I would reconsider the rent-free aspect, it’s easy to let that extend for longer than you mean to and your GF may not be comfortable asking you to pay rent. But that’s not what you asked about, so let’s get on to the main question. I think I would do 50-50 to each. That will let you get the debt down significantly while still giving you a nice sum of money for an emergency fund. But then I’m all about putting off decisions as long as possible.
Glblguy @ Gather Little By Little
I agree with Pinyo on living rent free as well. I think you need to pay your share of the rent. That’s the responsible thing to do.
Regarding your debt and savings. I would save a small emergency fund of say $1000.00. This will keep you from utilizing credit in the event of an “emergency” such as you car breaking down, unexpected medical bills, co-pays, etc. Once that is saved, I’d apply the remainder to your debt. Once your debt is paid off, I would then begin saving the 3-6 months emergency fund.
If you are familiar with Dave Ramsey’s baby steps, my advice should look familiar. I’m a firm believer in Dave’s plan.
Good luck, and pay 1/2 that rent!
Do what is best for you. Our responses are similar, but they are based on what we would do in that situation. In the end you need to talk with your girlfriend and make the decision that works the best for your situation. I’d like to remind you that it may not be possible to answer every question and none of use are financial professionals, so please consult with a professional before making any major financial decisions!