No matter what decision you ultimately make, you’ve had to make a tough choice.

These are actually quite minor choices when compared to the choice I’m talking about today.

I’ve been struggling with the problem of how to decide what’s most important to me and my family: pay down debt or save for emergencies.

I realize how important it is to have a substantial emergency fund to tide you over when you’re trying to get out of debt. But I want to make the most financially beneficial decision I can make for my family, and one pat answer doesn’t seem to fit all situations.

Assuming you’re disciplined enough to follow through on any particular plan you make, you have options other than the standard idea of saving up $1,000 before you start paying off debt (Dave Ramsey’s famous “baby step 1”).

Assuming you have $1,000 of credit available for use in an emergency, and assuming your interest rates on the cards where you’re carrying a balance are on the high side, you can save plenty of interest by paying off debt before you start saving up an emergency fund.

However, that said, there are some things to take into consideration.

1. A cash emergency fund can be used in situations where credit might not.

Say you need to rush your dog to the veterinarian after he’s hit by a car. Your local vet is cheaper and closer, but he doesn’t take credit. A cash emergency fund might be the thing that gets your dog the care he needs for a price you won’t mind paying in the long term. This situation might be a stretch, but then again, I live in a rural area and I know several vets who don’t take credit cards and who need to be paid when services are rendered. The closest “big” city is an hour away.

The way I’ve found to get around this is to make use of the cash I have put aside for my budgeted irregular expenses. Although this cash is technically already assigned a task, in a pinch, it gives me cash reserves to tap into in the event of an emergency where only cash will do.

2. If you can’t repay the emergency expenditure quickly, your emergency will end up costing you interest, which you could have been paying toward your debt.

In simple terms, if you save up an emergency fund in an account that compounds daily at a 1% annual interest rate instead of paying on a debt that compounds daily at a reasonable 7% annual interest rate, you’ve lost 6% of your money to interest payments.

However, if you then have to charge something on a credit card because of a true emergency and it takes you 6 months to repay the money, your emergency has cost you 3.5% more than it would have if you’d paid cash.

Here’s what it looks like in dollars, roughly.

$1000 in the bank + $10 interest earned if you save a cash emergency fund

$1000 less debt + $70 interest saved if you pay debt first

$1000 debt + $35 interest paid if you have an emergency that would have used all your emergency funds and you’re able to repay within 6 months. If it takes you 12 months, you’ll pay $70 interest.

However, if you don’t have a card with a relatively low interest rate, there’s another possible downside. The interest paid on a card with a relatively high rate could be damagingly high.

You could get into a cycle of debt that takes many more months to pay off than you might ever have saved by paying debt before saving for emergencies.

If you pay late, you could be subject to high penalties, usually starting around $39, and your interest rate could jump even higher.

Net savings by choosing to pay off debt instead of saving for emergencies

Here’s a summary of the financial impact of one choice over the other.

Best case

The best case assumes you have no emergencies while you’re paying off your debt.

Pay off debt: Net worth up by $1,070

Save for emergencies: Net worth up by $1,010

Worst case

The worst case assumes you have an emergency that uses your entire “fund” and that you take 12 months to repay your emergency charge.

Pay off debt: Net worth down by $70

Save for emergencies: Net worth up by $10

Somewhere in the middle

Somewhere in the middle assumes you take 6 months to pay off your emergency charge.

Pay off debt: Net worth down by $35

Save for emergencies: Net worth up by $10

My decision

All that said, I made my decision not long after I’d decided to pay off my debt as quickly as possible. I chose to put as much of my discretionary funds toward paying off debt as soon as possible. My irregular expenses savings remains my only cash reserves at the moment, and although I rethink the issue every month or so, just to be sure nothing’s changed that might impact my decision, I believe I’ve made the right choice for me for the time being.

Truly, it’s somewhat of a gamble, but the payoff of getting out of debt sooner than I would have otherwise seems worth the risk to me.

Have you had to make a similar decision? What did you decide? Comments or questions are always welcome.

Why aren’t interest rates and amounts owed the most important factors?

First, interest rates and amounts owed do exclusively determine the amount of money you’ll ultimately be paying back. Time is a factor, but not in the same sense that interest rates and money owed are.

If you want to payoff your debt in a way that saves you the most money over the long term, based on your current situation, you need to choose to pay off your debts with the highest interest rates first. A higher interest rate means you pay back more dollar for dollar on a debt. If you owe $1,000 at a 10% interest rate, your monthly interest payment (using simple interest) is about $8.33. If you owe $1,000 at an 18% interest rate, your monthly interest payment is about $15. This is a simple way to decide what comes first in your debt payoff.

If you’re more interested in the motivational aspects of paying off debts quickly, you can start with the smaller amounts first and work your way up to the larger debts. This gives you a boost every time you pay something off, inspiring you to keep at it.

However, sometimes other issues come into play when you start working on your debt payoff plan. In fact, you should always consider other factors in your decision-making.

My problem

I have several smaller debts with low interest rates. I also have a few with larger balances that have higher interest rates.

My ideal plan would have been to pay off debt in a way that saves me the most money. I like money and I especially like it when I can keep as much of it as possible in my pockets.

My debts

The thing is, I would like to pay off the camper before the American Express bill because the interest rate is so much more favorable. However, with the current state of the economy and the ever-changing nature of credit card agreements, I worry that my American Express credit card terms will change drastically and unexpectedly and I’ll lose that lovely 3.99% interest rate until the balance is paid off. Then, depending on how high the rate jumps, any savings I could have accumulated by paying on the 8% debt first would be lost in a matter of months.

I have friends who are dealing with unscrupulous credit card companies right now and I have little faith in them myself these days. My biggest fear is that before the new credit card agreement rules go into effect later in the year, many credit card companies might try to take advantage of as many loopholes in the credit card agreements as possible to keep from having customers locked in with very favorable terms long-term.

Maybe I’m overly cynical, but I don’t think so. Do you?

All the reasons I mention above are reasons in favor of taking your entire financial picture into account when you start laying out your debt repayment plan or your debt snowball.

Arrange your payoffs to suit you and your needs and don’t worry so much about following any particular person’s specific method for deciding on a debt payoff order. As long as you’re paying something down with the intention of paying it off, you’re making progress!

Back in the spring, I bought a couch. I’d like to claim I paid cash for it, but I can’t. I needed a couch quickly and I took the easy way out. I bought the couch on credit.

I did have sense enough to find a store running a “no interest until June 2009″ deal, so I haven’t paid any interest on the couch. However, the special “no payments” part of the deal almost caught me… I put off starting my monthly payments when I should have, and I’ve ended up having to pay higher monthly amounts to get me to paid off before the “no interest, no payments” period runs out.

I’ll make it in just under the wire. I owe $409.13 and have been paying regularly these days. My hope is to have a little extra left over from Christmas bonuses to pay it down faster (if I even get one with all the financial crises going on right now).

My plan is to take that $50 monthly amount I’m paying and put it toward my car payment. This will effectively start my debt snowball.

Technically, spring is probably when my debt payments are first going to snowball, but I’m thinking of it as having already started. I’ve packing my snowball and I’m getting ready to let it loose down the hill. As soon as that first payment is applied to something else, it will have officially begun to pick up speed.

I have my list of debts, in the order I want to pay them off.

Although many experts suggest either paying off higher interest debts first or debts with the lowest payments, I’ve come up with my own schedule, for my own reasons. For this to be successful, that’s what we all have to do—find something that works for each of us, giving us the most motivation. If you find that you’re more motivated by the thought of saving money you would have ended up paying as interest, by all means, you would want to list your debts in order of highest interest rate to lowest.

My choice of debt payoff order

1. JCPenney (couch) – 0% interest, but raises dramatically if the debt goes past a certain date
2. Auto Loan – 6.9%
3. Camper – 8.25%
4. American Express – 3.9%
5. Student Loan – 3.25%

I chose this schedule because it will get the snowball going the fastest. I already feel tons of motivation at the idea of paying off my car and knowing that payment amount will go toward paying off the camper. It’s exciting to dream about the day when I can actually make it happen.

Do you have a debt payoff schedule? How did you chose to rank your debts? I would love to know.