Should I Pay Off Debt or Build an Emergency Fund?

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When people are trying to improve their financial lives, a common question comes up: which should I focus on first, paying off debt, or building an emergency fund?  Of course, the answer is that BOTH of those goals are incredibly important.  But sometimes you must choose to focus on one first, and that is totally fine.  Let’s talk about when you would choose one path over the other for your initial focus.

Focus on paying down debt first if . . .

. . . you are barely making ends meet.

. . . you are living paycheck to paycheck and only making minimum payments on your credit cards.

If those describe your situation, you should focus on getting your debts under control before you focus on building savings.  The idea is that you need to get your financial situation stabilized before you can start building for your future.  Carrying a bunch of debt is a challenge for your monthly cash flow.  But debt is also a measure of your financial worthiness.

What I mean by that is your credit score is more important than ever.  Whether you can borrow to buy a car or a home is directly related to how good your credit is.  The interest rate you are offered for such a loan is also a direct result of your credit score.

Your focus should be on cutting expenses and increasing your income as much as you possibly can in order to apply as much monthly income to your debts as you can.  Your goal should be to get all your credit card debt paid off first.  Once you do that, you can reevaluate whether it is time to split your efforts between building an emergency fund and tackling the rest of your debts.

Focus on building an emergency fund first if . . .

. . . you are making your minimum debt payments each month easily.

. . . you tend to lean on debt when an unexpected expense comes up.

If those describe your situation, you might consider focusing on building your emergency fund before getting serious about paying off your debts.  There is a part of me that always wants debt paid off first, especially credit card debt.  However, if things are stable in your financial life, you would do well to start establishing a new pattern for yourself.

Continue making the minimum payments on your debts and focus on getting a small amount saved for a rainy day.  Initially, set your goal at a low, easily obtainable amount.  Perhaps you start by saving $100.  Then you can increase your target to $200 or $500.  As you achieve each level, raise the bar to a higher level.  Your ultimate goal should be $5,000 or an amount equal to three months’ worth of your monthly household expenses, whichever is greater.  The goal is to have a cushion that can help when unexpected expenses arise.  It is best to break the habit of turning to debt to fund budget shortfalls.

The next step is to adjust your focus to include your debt pay-off goal.  Redirect some of what you had been saving each month to increase the amount you are paying on one of your debts.  Continue to split your efforts until you get your emergency fund up to an amount that is equal to six months’ worth of your monthly household expenses.

Once you are there, shift your focus again.  This time, double down and put all your extra income into systematically paying off your remaining debts.  Before long, you’ll be debt free and have a healthy cash cushion for emergencies.

You can do this!

 

Do you struggle to save for a rainy day while also paying off debts?  Share below!  Or if you want to start a discussion with some like-minded friends, join the free SimpleMoney Community on Facebook to share your thoughts!

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