I've recently been awarded a bonus of 6500 EUR (Net), What would be the best approach for me?

Here is what my financial situation roughly looks like.

  • 6200 EUR @ 4,95% (4291,63 still open) 29 months left.
  • 7500 EUR @ 5,50% (6844,70 still open) 38 months left.
  • NO credit card debt
  • NO emergency funds
  • Expecting 5k tax refund in februari.
  • Stable income, can save 400 a month

My first obvious choice would have been to pay off the 5,50% loan completely, but that would leave nothing left for an emergency fund. Is that a smart thing to do? Since I am talking about loans here, paying them back early involves a penalty the interest for 2 months, which is not that much.

  • Is the €400/mth in your last bullet point used for interest payments on your 2 loans? – Lawrence Sep 6 '19 at 13:45
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    Ignoring the bonus, if you can save $400/month, you should be paying down the debt faster and contributing to an emergency fund. – chepner Sep 6 '19 at 13:45
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    Aside from the marked question which has some great material, the key question for you is what your monthly expenses are - once you have something like 3-6 months of expenses saved up in an emergency fund, paying down the debt seems like a really good idea. If you have a really good safety net (living with parents etc.), you may want to consider not having an emergency fund at all, to pay down the debt faster. – Grade 'Eh' Bacon Sep 6 '19 at 13:47
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    Regardless of what you do now, it sounds like you have ability to pay off both loans in full within the next 6 months. The question is, are you comfortable with no emergency fund until then, or are you willing to start building that up now at the cost of whatever interest you'll pay over the next 6 months? – chepner Sep 6 '19 at 13:50
  • It is strange to justify "emergency" when you have debt commitment. If you are worried about uncertain risk, you should get adequate insurance. – mootmoot Sep 6 '19 at 16:41

On paper, paying the higher-interest debt back first with the entire bonus amount is the most straightforward solution. However, many people will tell you to establish an emergency fund with some of the money. This may make sense for you, but (like pretty much all financial decisions) it boils down to risk tolerance. What are the chances that you will have a financial emergency in the near future? If you are nervous about that risk, set some money aside now. But keep in mind that doing so means you are paying more interest on the debt you owe. So - it's a tradeoff - by establishing the emergency fund now you pay slightly more over time in order to have a hedge against risk. Some people will be in a stable enough life situation where an emergency fund isn't a high priority (i.e. you have good health insurance, live with your parents, walk to work, and don't own anything like a car or house that could incur unexpected expenses). Those people may choose not to save for an emergency fund. Other people may be in riskier situations (own a home, own a car that they need in order to get to work, contract job, family to support, etc) and for those people, paying a little extra interest on the debt will be an easy trade off for some security.

Also, since you mention that you can save each month, it's worth considering that the 400 euro you can potentially save in a given month is just a mini version of this same decision. Unless you have some tax-advantaged retirement plan option available, it usually doesn't make sense to budget for long-term savings (i.e. anything beyond an emergency fund) while you still have unsecured high interest debt.

All that said, your immediate plan should be something along the lines of:

  • Decide if you want an emergency fund, and how much. Set aside from your bonus or monthly savings until you reach that amount.
  • Pay the rest of your bonus or monthly savings towards your highest debt, until those two loans are paid off.
  • Plan for long term savings and contribute from your 400 a month towards that as appropriate.
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