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How to Start an Emergency Fund While You Pay Down Student Loans

Nov. 25, 2015
Loans, Student Loans
How to Start an Emergency Fund While You Pay Down Student Loans
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Your car mechanic says the transmission needs to be fixed, but without an extra few thousand dollars in reserves, you’re forced to pay with a credit card. You take months to pay it off, racking up interest charges along the way.

Imagine instead that you have a savings fund specifically for emergencies. You dip into it to pay for the repairs, make a plan to replenish your account and move on with your life.

It might sound impossible to save when student loan payments shrink your bank account every month, but an emergency fund will keep you from going into deeper debt when you’re faced with an unexpected expense. The trick is to build one up slowly while you continue to make the required monthly payment toward your student loans — then shift your energy to paying off your debt. Here’s how to do it.

1. Understand the purpose of an emergency fund

You may already be saving money each month for retirement, a down payment or for a short-term goal such as a vacation or new car. But an emergency fund would pay for the expenses you didn’t know you’d have, like an emergency-room visit not covered by your health insurance. You also want a safety net if you suddenly lose your job and still need to pay your bills.

Your goal should be to avoid using a credit card to pay for a big, unexpected cost or for your living expenses if you’re unemployed. A $500 or $1,000 charge can sit on your credit card for months, and because it will accrue interest, you could end up owing a lot more than the original expense. When student loans are on your mind, preventing additional debt should be your top priority.

2. Settle on an account goal

The size of your savings account will depend primarily on how much you spend every month. A common rule of thumb is to save three months’ worth of living expenses, or what you usually spend on rent, food, student loan payments, utility bills and transportation. That will keep you afloat if you lose your job and need some time to find a new one.

If you can’t rely on support from others in a financial emergency, it’s a good idea to save more — say, six months’ worth of expenses — in case you’re out of work longer.

But don’t let the fact that you don’t have that amount now prevent you from saving at all. Just a few hundred dollars is a great start if you don’t yet have anything saved.

3. Fund your account

The easiest way to build up an emergency fund is to set up an automatic funds transfer from your checking account to a linked savings account. Transfer $100 or $200 to savings after each payday until you reach your emergency-fund goal. You can also choose to deposit larger amounts to your account when you have them.

Although you shouldn’t wait until you get a windfall to start saving, you can supplement smaller transfers from your paychecks with these sources:

  • Tax refund
  • Annual bonus
  • Birthday or holiday cash gifts
  • Cash-back rewards from credit cards (Go this route only if you pay off your credit cards in full each month)
  • Proceeds from selling clothes, books or furniture you don’t use

4. Pay extra toward your loans

Once you’re used to saving money, it will be easier to put that same amount toward your student loans. As soon as your emergency fund reaches your desired level, stop your automatic transfer to savings and redirect it to your student loan servicer.

Be strategic about which loans you pay down first. Prioritize paying off high-interest loans — particularly those with an interest rate higher than 7% — so you’re not stuck making big interest payments for years. You can also bring down your interest rates by refinancing your student loans, a process during which a private lender will offer you a new rate based on your credit score.

Learn more: 10 Questions You Should Ask Before Refinancing Your Student Loans

Another option is to pay off smaller loans one by one. You won’t save as much money as if you had paid off your high-interest loans first, but fully getting rid of loans early on might motivate you. Either way, call your student loan servicer to ask how you can target your payments to certain loans or loan groups. NerdWallet’s guides to working with these servicers can help:

FedLoan Servicing

Great Lakes



If any of your loans carry an interest rate below 7%, consider saving for retirement instead of paying them off completely (as always, continue to make your minimum required monthly loan payments). The average stock market investor sees a 7% increase in the value of their investments long term. You’ll likely save more by investing than if you spend the same amount paying down your loans.

The takeaway

Think of your emergency fund as the foundation of your finances. Once it’s set up, you can focus on other smart — and fun — ways to spend your money.

Check out NerdWallet’s additional student loan resources, which will help you round out your student loan repayment strategy:

Pick the Best Student Loan Repayment Plan in 3 Simple Steps

NerdWallet’s Guide to Consolidating Federal Student Loans

Student Loans: Decide Whether to Refinance or Keep the Standard Plan

Brianna McGurran is a staff writer at NerdWallet. Email: [email protected]. Twitter: @briannamcscribe.

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