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My cash reserves are around $11k, including an emergency fund of about a month and a half, and I budget rigorously. The only debt I have is $7k at zero interest, paid at $300/month, and it's from a family member who would almost certainly defer payments if something catastrophic happened. (BTW, our family has successfully made and paid tens of thousand of dollars of inter-member debt for many years, and the bankers and lenders vary over time.)

I happen to be in a free Dave Ramsey class, and a question came up. Should I pay off the zero interest debt before finishing my emergency fund? If so, why? My inclination is to finish accumulating my emergency fund first. The only substantive argument I can see to pay early is an emotional one: it's appealing and secure to have zero debt. Paying it off early will actually cost me money, because inflation is decreasing the value of the debt over time. My job is extremely stable, and also it's a rotating 12 month contract where I doubt they ever break the contract.

P.S. I should be honest and admit I'm currently throwing away some 401k match; my employer matches an incredible 9% 1-for-1 but I can only afford 8% while I'm getting on my feet. I've calculated that 8.5% is sufficient for my retirement.

Dheer
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Paul
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3 Answers3

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First I must say that I'm not a Ramsey fan. Sometimes loans will make your financial situation significantly better. Especially if its a 0% loan. Generally, I do think that leveraging has its place, its the ab-use of loans what causes problems, not the use.

Re your question - you're right in trying to first build up an emergency fund. You should have enough in it to be able to pay for yourself for at least half a year of unemployment or zero income. You only have one month.

Your family member gave you money for free, which is admirable, but I'm sure there's a limit to everyone's generosity and he might not give it to you for free again, once you pay it off. Thus, you should be able to handle your future troubles on your own, and emergency fund is a crucial part of this.

Pay as agreed, try not to be late, and you'll pay the loan off within 3 years. If you accumulate enough emergency fund, and you still have some extra left - pay some extra on the loan in order to pay it off early.

Do make sure you take full advantage of the employer's 401k match. This has, IMHO, much higher priority than paying off the 0% loan early.

littleadv
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I´d like to offer another perspective, neglected in the other Answers.

  1. The loaned money is not zero-interest. It will cost your family-member some opportunity-cost to lend it to you vs investing it elsewhere. You have to realize that this part, the interest of the loan, is a gift from this person.

  2. I don´t know the condition under which the loan came to be, but it can make sense to build a history of trust. Having good credit inside your family can be a worth of its own, and apparently also serves as a kind of emergency fund until you build your own. You will presumably be more likely to get another family loan if you need it, when you show you don´t take advantage of it.

I think the best course of action is to play with open cards and discuss the financial options with your respective family member. If they are old-fashioned and would keep the money in a savings-account anyways, it will not make much of a difference. If they are actively managing their assets, the might appreciate your early payback. I any event you will gain peace-of-mind and trust from your investor.

Daniel
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First, I must say I am a Ramsey fan.

Here's the thing, the borrower is slave to the lender, so if you eat Thanksgiving dinner with your generous relative next week, the food will taste different. Before I was a Dave fan, I borrowed money from my cousin once, and that debt was always hanging over my head. At times, it made hanging out awkward since I had money to 'go out' but not money to 'pay back.' It felt great once I paid him off, but the awkwardness was never cool.

I'm sure some will disagree (Dave wouldn't), but if you TEMPORARILY stop your 8% contribution, and combine that with your current margin, you could pay off the debt from your cash flow and complete your emergency fund. Since you said that $11k is 1.5 month's expenses, you would essentially need to double that for a three-month fund or quadruple it for a six month fund. I know $300 may not seem like a lot, but since I value family over money, I would pay that off today out of the $11k and then replenish and fill the emergency fund.

Also, your expenses will have dropped by $300/mo., so it will take less money to get to three or six month's expenses. Once that's complete, get your full 8% contribution.

FYI: I consider margin to be the difference between your income and your outgo.

Waddler
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