Create EF fund or Pay down debt

[DebtFreeGoal]

I'm currently struggling to decide if I should build my emergency fund or pay off a debt that I have. I currently have a 9 month CD account with a .658% rate and a balance of $500. Its a add-on CD so I can make deposits of $500 a month to it. I owe on a debt to a relative with a balance of $8733 and I pay $200 a month with no interest. I have roughly $1500 a month in excess funds once my bills are paid off. These were my options.

1. Continue paying $200 a month toward the debt and apply the $1500 a month toward CD account
2. Apply the additional $1500 to the debt (having a total monthly payment of $1700) then once debt is paid off build emergency fund.

I'm in a pretty stable job but I'm at odds on which route would be the best to take. Please keep in mind that the $1500 excess will decrease in January when I will have to begin repaying my student loans which will be roughly $500/month.

[zibazinski]

An interest free loan is golden. As long as they don't need the cash or aren't going to charge you interest, I'd build up my EF. You can always take from EF if the situation changes. In January, you will have 2 debts going out, one for 500 and one for 200, that still leaves you a grand to put away in cd fund. Can you access cd fund if you need it? Not worried about penalty because at that low of an interest rate-big deal.

[Deleted]

Increase your EF to $1000 then pay off the loan as quickly as you can.

[Gardening Grandma]

I'd definitely work on building the EF up to $1000. And while I agree that an interest free loan is nice, because it is to a relative, I'd pay it off asap after the EF reached $1000.

Relatives are different. Owing a realative money affects the relationship.

[qofcc]

Do you have other credit available in case of an emergency or would you end up borrowing money back from this relative? If the relative considered this a hand up to get you back on your feet, then they would probably prefer you get back on your feet before paying them back. I'm sure they don't want to get all the money back and loan it out to you again. Personally, I'd find that irritating. On the other hand, once you have sufficient money set aside in your EF or available credit, you should pay them back ASAP. Again, they're not a bank and they're doing you a favor.

[DebtFreeGoal]

I believe theres a penalty if I were to withdraw the money from the CD prior to the maturity date, but I don't think it would be a significant penalty. I was planning on possibly keep $500 in my regular savings to touch if any emergencies come up and I didn't want to get a penalty from withdrawing from my CD

[DebtFreeGoal]

I agree that owing a relative can be a sticky relationship but in my case its really not a bad situation at all. I've actually paid down the debt quicker than what I initally told the person so they are pretty satisfied with it. I think after I build up my EF to cover at least 6 months of expenses I will begin paying down the debt to my relative. My goal is to have it paid off by next June.

[Gardening Grandma]

Jun 7, 2011 12:16:50 GMT -5 DebtFreeGoal said:

I believe theres a penalty if I were to withdraw the money from the CD prior to the maturity date, but I don't think it would be a significant penalty. I was planning on possibly keep $500 in my regular savings to touch if any emergencies come up and I didn't want to get a penalty from withdrawing from my CD

I'd leave the CD alone. It can be your EF in the CD..... If there was an emergency such that you HAD to withdraw it, then that's one thing, but I'd just leave it there and either save another $500 in a savings account, or add to the CD until it is at $1000.

[haapai]

Are you currently living with said relative? The size of your monthly surplus suggests a pretty sweet housing deal.

[Deleted]

I would open a high yield saving at ing direct or HSBC etc, they offer 1% and you can withdraw the money at any time vs the CD. But to answer the question I would continue paying the $200 until you get the EF up to 3 months, therefore you do not need to borrow from him/her again.

[Tiny]

Since you've only got $500 in savings and no way to pay the Relative in Full should they 'call the loan' because they NEED the money - which they probably won't but it would make me want to get that loan paid in a reasonable amount of time (assuming the relative gave it to you with the intent of helping you...)

At $200 a month you'll payback the relative in 44 months. I'd work out some other schedule maybe 18 months or a 12 month payback? so something like $500 a month (for 18 months) or $700 a month (for 12 months).

I'd probably do this for June thru Dec 2011:
$200 scheduled/agreed upon payment to relative
$500 added payment to speed up the payment to relative
$1000 to savings

So, on Jan 1 you'd have $7500 in savings, and owe your relative $3833
For the next 5 months (jan - april 2012) I'd work it thru like this:
$200 scheduled/agreed upon payment to relative
$500 added payment to speed up the payment to relative
$500 to savings
$500 to student loan

This way in 12 months you'll be done paying your relative, you'll have started paying on your SL and you'll have built an EF of about 10K. In June of 2012 I'd look at the interest rates on your SLs and then decide if they were keepers or needed to have their payment accelerated.

FWIW: Right now I'd review your retirement strategy... if you planning to pay off your debts and then save for retirement I'd rethink that and get some money going to retirement - either contributing up to the match in your Employer's 401(k) or getting 5K into a Roth for 2011. Make it automatic NOW - even if it cuts alittle into building your EF (ie $400 a month to retirement and only $600 amonth to EF). Once you've paid off the relative OR have build up an EF (maybe 3 months of expenses?) you can bump up retirement savings or start other investments.

[DebtFreeGoal]

haapai, to answer your question, no I'm not living with the relative. My surplus is primarily due to me not having any major debt such as credit cards.

[DebtFreeGoal]

ATSiaRU

I really like how you broke down paying off the debt and adding to my EF. I'm seriously thinking about utilizing the options you offered. To answer your point regarding retirement I currently contribute to my company's 401k plan at 6% and I get a match of 6% from my company so I think I'm doing fairly well in that department. I also have a Roth account but I admit that I haven't been fully funding it. It will be a move once I pay the debt down and have a sizable EF built up. Thanks for the good scenarios provided.

[phil5185]

Good job so far! I would quickly pay off the $8700 loan, free loans from relatives add strain, even tho you don't think so. (My 'kids' are 40-ish, I never say 'no' to a free loan if they are in need - but that is money that I could be earning 10% to 12% on, so it's not 'free' to me - but it's my duty .) It would only take 5 months at $1700/m.

And I would not tie up cash in CDs that pay <1%, just keep your money in your savings or checking account.

I currently contribute to my company's 401k plan at 6% and I get a match of 6% so I think I'm doing fairly well in that department.

Good! You get an instant 100% return on your contribution plus a tax break. But there is one more important factor - what are you investing that 12% in? Just as you can never build wealth with <1% CDs, nearly ALL of your wealth will come from 10% and 12% choices in your investing.
Remember, a 0.658% CD is taxable, so you end up with only 0.5%. If inflation is at 2% you are losing 1.5%/yr. You're getting safe storage of your money, but at a price. Conversely, your 11%/yr investments outpace inflation by a large margin, it grows tax deferred, and your wealth builds.

Eg, if the 12% that is invested in your 401k was $6000/yr, that would be $1,300,000 in 30 yrs, invested at 11%/yr.

[runewell]

Jun 7, 2011 12:16:50 GMT -5 DebtFreeGoal said:

I believe theres a penalty if I were to withdraw the money from the CD prior to the maturity date, but I don't think it would be a significant penalty. I was planning on possibly keep $500 in my regular savings to touch if any emergencies come up and I didn't want to get a penalty from withdrawing from my CD

The penalty is usually so many months of interest, and you're not making squat on the interest rate, so the penalty is no big deal if you have to incur it.

[Tiny]

It's good you've got retirement savings going, so paying off your relative and eventually the SLs won't set you back.

Another way to look at your 'problem' or maybe it's a 'puzzle' would be to play some Make Believe and think about where you want to be financially 12 months, 2 years, 3 years, 5 years from now. Once you decide on were you want to go/be - you'll know how to allocate your money to acheive those goals. Having goals makes decision making alot easier...

[DebtFreeGoal]

phil5185,

To answer your question my 401k is currently invested 90% in a target fund and 10% in an international fund. Both have done fairly good and I'm never overly suprised by any deep decrease in my account balance. I'm sure there's more I can do to get a better return on my investments.

[phil5185]

To answer your question my 401k is currently invested 90% in a target fund and 10% in an international fund.

Good choice. And I checked the Vanguard2050, looks like it nearly doubled in the last 24 months.

[debtheaven]

Frankly if you have all that extra money right now, I don't think it's right to only be paying your relative back 200/mo. It's not because it's an interest-free loan that it should go on forever.

I'd pay them 1200/mo till the end of the year, and put 500/mo into my EF. Or 1000/mo to the relative and 700/mo to the EF and / or other expenses, if you're more comfortable with that.

But paying them 1200/mo for the next seven months would pretty much knock out that loan before your SLs kick in: you'd only have one payment of 333 left in January.

ETA: If you're paying them back quickly and something comes up, you could always go with the original 200/mo payment. But personally I'd aim to knock out most or all of it before the SLs kick in.