Not long ago, I participated in a lively conversation in the GRS forums entitled: Debt Snowball vs. Emergency Fund. The premise is very simple. Should the person start an emergency fund while he’s still in debt? In this case, we are talking specifically about credit card debt averaging 15% in interest.
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In this article, we will follow this sample scenario: A man (we’ll call him Jerry) owes $5,000 in credit card debt at 15% interest rate. The monthly minimum payment on his credit cards is $100 per month. Jerry could pay $200 per month maximum.
If you are a Dave Ramsey fan, the answer is simple: “Start a $1,000 emergency fund then pay off debt using the Debt Snowball“. This way, you don’t have to rely on your credit cards in case of an emergency. If we follow the scenario above, Jerry would:
All in all, it took Jerry 38 months and $1,462.20 in interest payment to get rid of the $5,000 debt and build $1,000 emergency fund.
While I think Dave Ramsey’s plan is fine, I wouldn’t do it his way if I were in that situation. Personally, I want to use everything in my arsenal to pay down my debt as fast as I could. If we follow the scenario above, Jerry would:
All in all, it took Jerry 36 months and $1,032.20 in interest payment to get rid of the $5,000 debt and build $1,000 emergency fund. The difference is approximately $400, or almost 10% of $5,000!
Note: You could try out the various scenarios using the Bankrate credit card payment calculator.
Okay, some of you may ask what would I do if I run into an emergency while I don’t have an emergency fund. The answer is quite simple. I would use my credit cards as my emergency fund.
What would you do if you were in this situation?