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July 21, 2006


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The emergency fund.

Depending on your circumstance, it can take years to get out of debt, but an emergency can strike in an instant and blow you clean out of orbit. If you're living paycheck to paycheck, and you don't even have that little bit of money saved, it can make it harder to get through the hard times. Not everyone has good credit, or helpful relatives or friends that can be borrowed from in an emergency, but everyone can save a little.

I like the incremental approach. Get a little in savings to cover you during a small emergency will keep you from adding to your debt. Also, it is not only a practical decision based on math. It has to do with peace-of-mind. Many people would like the security of the 1,000 or so in the bank.

We pay off debt first. We do have an emergency fund but it is actually a debt paydown fund in disguise. We save money in it for 5-6 months; then we put down $10,000 every six months on our mortgage (sometimes it is more and sometimes it is less but we always put down a lump sum payment biannually). The emergency fund goes down to about $1000 when we do our six month paydown and then starts to build up again. A fluctuating savings account of this sort can therefore serve two purposes: first debt pay down and secondly, emergencies.

If you get really creative and save lots, you can also use it to fund other regular recurrent expenses such as property taxes, insurance and special once in a while expenses such as the endless housing projects : the deck, the landscaping and the inevitable repairs.

If we have a real emergency, we take on an extra job. If you have only one debt which is your house, it is easier to manage life's problems with a smaller emergency fund. In addition, if one of the people in a marriage is earning a living wage as opposed to a dying wage (minimum wage) then the other spouse is able to supplement the household income by casual work, weekend work at lower rates of renumeration. Every penny I earn from casual work goes to the mortgage pay down.

Of course, if there is a major illness, diability or accident, all this debt pay down would cease ASAP. But I believe we would still be in a better position with less debt. After all, where would all the money we are using to pay down debt go to otherwise? Consumption? I think not.

I'm strongly inclined to say "pay off debt first". But that may be an artifact of my life situation and experiences.

I have a friend who got a buyout from her employer...she was lucky, and managed to get $80,000 from them to leave 6 months before she would have been laid off with nothing. As it turns out, I was the only person who advised her to use the money, first and foremost, to pay off her outstanding debts. She listened to her other friends instead, and now she's stuck, several years later, with all the money gone, nothing much to show for it, and still having to make debt payments every month...for which she usually has to borrow from friends. And this is not new debt from new consumption, either...this is the same old stuff she could have easily paid off with that severance money, and now be able to actually live on her current income.

Then of course there's my own situation. Once my fiancee and I get married and move into the house, the overwhelming majority of my nonnegotiable living expenses are going to be in the form of debt service (on the mortgage). (Right now it's split evenly between the mortgage and my rent.)

Is there an emergency fund? Sure. But it's sized more according to the assumption that it will get us by until we can refinance (and thus cut our monthly obligations) than according to the assumption that it can support us until we get new jobs at or above our current income level to replace a sudden loss of the ones we have now. I've seen how long that can take, and saving up that much money in cash at this point is unrealistic.

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