This article discusses the pros and cons of paying off debt or building emergency fund first.
Debt is a ball and chain that can affect your quality of life for years to come. The question should not be whether you should pay off debt but how much should be paid off each month.
As we all know, debt is a common problem for a lot of us. It's like a way of life, and that's totally fine. When it comes to paying off debt, some people believe that you should prioritize paying off credit card debt and student loans. Others think that you should focus on building up an emergency fund first, so that if anything goes wrong financially, you have a safety net.
To Pay Off Debt First or Build Emergency Fund?
Paying off debt or building an emergency fund is something most people have difficulty prioritizing.
The answer depends on each person’s unique situation. The ideal situation is to have a robust emergency fund and no debt, but being in debt can be a sign of being financially irresponsible. Paying off the debt first could help the person establish a better savings plan, which will build their emergency fund more quickly.
But there are other factors that need to be taken into account when considering this question: “Which debts are you taking care of? How much money have you saved in case emergency situations? Is your income stable enough to pay monthly bills without borrowing from your emergency funds?”
A financial emergency can just happen at any moment, and most of the time, it happens without warning so we must arm ourselves with backup plans and funds to get through it smoothly. It may be caused by a natural disaster, accident, or sudden job loss. It is important to have an emergency fund on hand in order to help you get through these tough times.
Paying off debt will reduce your monthly expenses and give you some breathing room in the future when you are finally debt-free and can focus on saving money and building up your emergency fund.
If the goal is to build an emergency fund, then it may take longer before you can do so because of the additional payments needed for your debt.
Choosing Between Paying Off Debt and Building Emergency Fund Can Be Difficult
Everyone has their own opinion on this topic and it is not as easy as it sounds.
Some people think that it is better to pay off debt first because they are incurring interest rates on the interest rate whereas if they were to save money in their emergency fund, they would be earning interest on the money saved.
Others think that paying off debt will make them feel more secure in case of an emergency.
Others disagree with this idea because there are typically no penalties for withdrawing from the emergency fund unlike with debt, so paying off debt should be a priority instead of building an emergency fund.
Pay Off Debt or Build Emergency Fund: The Drawbacks
Should you pay off debt or build an emergency fund first? This is a common question that many people will find themselves asking.
It is important to understand that there are benefits and drawbacks to each option.
Paying off debt comes with the benefit of having more money, less stress, and more money for emergencies.
The downside is if the items you are paying off are not an emergency, it could be smarter to save instead.
Building an emergency fund has the benefits of providing more protection in case of emergencies and providing peace of mind since you know you have funds available for emergencies instead of just hoping for the best.
The downside is if you have several debts which require higher interest rates than your emergency fund will earn, it may make sense to focus on paying those debts
Debt is often seen as a financial burden that we need to get rid of as quickly as possible. However, there are some situations where it can be beneficial to focus on building an emergency fund first.
The main reason why you should focus on building an emergency fund first is because it is a cushion for when things go wrong. It can save you from bankruptcy and help you maintain your lifestyle in the event of a job loss or other emergency.
So Which is Which?
It is a common question among people whether they should pay off their debt or build an emergency fund first. Once you have more information on what it will take to pay off your debts, you can decide which one is the best option for you.
Debt repayment calculator: Simple Loan Payoff Calculator to Save You Thousands
Debt can be a great investment if it’s used wisely. But for most people, it is more of a burden than anything else.
One of the most common questions people ask themselves when they owe money are: Should I focus on paying off my debts or building up an emergency fund?
The answer to this question depends on your financial situation and how much you make every year. If you want to pay off your debts quickly, make sure to maintain a healthy emergency fund at all times. But if you can afford to build up an emergency fund while having to pay your debt, you may also do so depending on your financial capacity. Only you can answer that.
To make the decision easier, ask yourself these questions:
- How much debt do I have?
- What is my emergency fund?
- What are my monthly expenses?
- How much money do I have saved for emergencies?
- Do I have any other debts that need to be paid off first?
Debt consolidation is a good idea if you have too many bills to pay and you can afford to consolidate them. Doing this will help you attain lower interest rates and lower monthly payments as well.
An emergency fund should be set up first to protect yourself from financial emergencies such as an illness or unemployment. You cannot rely on credit cards or other loans in these cases.
Having an emergency fund is one of the most important things that you should do before you start your retirement planning. It's a safety net that can provide financial stability in times of need.
The question is: How much should I save?
This is a very personal decision, but typical advice is to save at least six months’ worth of living expenses (or about $10,000).
If you have credit card debt, it may make more sense to pay off this debt first rather than build an emergency fund.
It all depends on your interest rates and the interest rates of the emergency fund account you choose.
Paying off debt by paying off small balances first is a sound strategy. However, it's hard to budget when you're in debt. Build an emergency fund if you can't pay your bills currently.
The answer to this question is a simple one: in a time when interest rates are so low, in most cases it’s better to pay off debt.
Debt is an expense. When you take on debt, you are paying someone else money for the privilege of borrowing it from them at higher than the typical market rate. So it makes sense that if you can get rid of your debt, your expenses will be lower and you will make more money at the end of the day.
2 Useful Methods to Get Rid of Debt
There are two methods for getting rid of debt – snowball or avalanche.
The snowball method would have you pay the minimum payments on your various debts with whatever you can afford. Once all of your debts are paid off, you start over with the next smallest balance, and so on.
The avalanche method would have you pay more towards the debt with the highest interest rate first.
So which one is right?
That's up to you to decide based on your financial situation and what’s most important for your needs.
There is no fixed formula for this, but of course, it would be nice to pay off debt. And if you want to build an emergency fund first, you can start by saving $1,000 in your savings account before paying off the debt.
The main disadvantage of not paying off debt first is that it can keep accumulating interest payments.
So, would you pay off your debt first, or build an emergency fund?
The answer to to whether paying off your debt first or building an emergency fund depends on your financial capacity and priorities. If you want to live in peace without any financial worries, then pay off debt first. But if you are risk-averse and don't like the idea of debt hanging over your head, then building an emergency fund would be a better option.
Debt can tie people down and this is why it's important to pay off debt before anything else. However, debt can be helpful in some cases where the interest rates are low or there is no interest at all. Not all types of debt can be forgiven by bankruptcy proceedings, so it's best not to get into more debt than necessary.
Building an emergency fund should always be on everyone's list of priorities because it safeguards against emergencies that have the potential to derail financial goals.
Read the Entire Debt Consolidation Series
- Your Complete Debt Consolidation Process
- Should You Use Debt Consolidation to Pay off Debt?
- 12 Best Books about Debt Relief and Credit Repair
- Avoiding Debt Settlement Disaster to Get Back on Track
- Payoff Review for Debt Consolidation Loans [No Hidden Fees]
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.