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Updated on Monday, April 25, 2016
When Michelle Schroeder-Gardner graduated with an MBA in finance in 2012, she had $40,000 in student loan debt. But by the middle of 2013, she was happily debt-free. “To pay it off in that time frame, I side hustled like crazy,” says Schroeder-Gardner, 26, who writes at MakingSenseofCents.com. “I was a freelance writer, mystery shopper, eBay seller, survey taker and more. I was working 100-hour weeks between my day job and my side jobs.”
In her final push to pay off her loans, Schroeder-Gardner and her husband used about $10,000 from their emergency fund—almost all of it—to pay off the balance. “It made us a little nervous, but we knew that we would still be fine due to our low budget and high income,” she says. “I didn’t want my student loans hanging over my head for years to come.”
Although it’s admirable—amazing, even—that Schroeder-Gardner eliminated $40,000 in student loan debt in less than a year, experts might disagree with her technique. Draining your emergency fund under circumstances that aren’t an emergency isn’t something they typically recommend.
When should you do this?
“Some of it has to do with life stage,” says Wes Brown, a financial planner in Knoxville, TN. “If you’re living at home in your parents’ basement, and other liabilities are at a minimum, and there’s a safety net, then I could see supporting this.”
In other words, if you’re not saddled with a variety of fixed expenses that would be at risk if you lost your job or needed to replace your roof, you’re a better candidate for wiping out your emergency fund to pay down debt.
You also may be in the clear if you have access to other kinds of liquidity, such as a home equity line of credit, or the Bank of Mom and Dad. “It could be that you have family members or friends who are willing to lend to you, or that you have good silver you could pawn or sell,” says Larry Luxenberg, a financial planner in New City, NY. “But whatever it is, you may need money in an emergency, so you need to be prepared for all sorts of contingencies.”
James Bryan, a financial planner in Edina, MN, agrees. “This isn’t a bad route in certain situations,” he says. “For example, if you’re 26, you live in an apartment, you have a pretty steady job and you don’t have a big car payment. But you have to make darn sure that you have excellent job security and you’re healthy and not at risk of any disability.”
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When shouldn’t you do this?
“If you don’t have any liquidity resources, I would say that’s a bad idea,” Luxenberg says. “A lot of things in your personal finances require patience and balancing things. Too much debt can be a bad thing, but a reasonable amount of debt for the right purposes can be a good thing.”
That’s because of all the debt you could have, student loan debt is one of the more favorable types. It’s typically lower cost than consumer debt, you get a tax break on the interest paid, and there’s often flexibility in payment plans if you fall on hard times. “The worst case scenario is where you use up your emergency fund to pay off student loan debt, and then you find yourself in a bind,” Brown says. “So you have to borrow from another line of credit to cover that, and you’re swapping a more favorable kind of debt for a less favorable kind.”
It’s also not a great plan to wipe out your emergency reserve if you’re carrying a mortgage. You could be one mortgage payment away from owning your home outright, but if you miss it because you lose your job and have no back-up cash, you could still be foreclosed on. And of course, there’s always unexpected maintenance. “A home is a massive responsibility,” Bryan says. “A roof, a new furnace, they cost a lot of money and they don’t give you a 12-month warning.”
What’s the best approach?
For most it will be keep that emergency reserve and address your debt the old-fashioned way—by paying it down paycheck by paycheck. If you have no emergency reserve, consider splitting your discretionary funds between savings and debt every time you get paid. That way you can achieve two goals at once. “You could use a simple equation like 70% toward debt and 30% toward savings,” says Nev Persaud, a financial planner in Atlanta. “You have to be wise in creating a balance.”