Pay off Debt vs Saving For Emergencies

Friday, July 13, 2012

Pay off Debt vs Saving For Emergencies

Which one should you do first?

Many Americans are in a tough position nowadays in which they have to choose between paying off their debt and saving up for an emergency fund.  Without an emergency fund, a person or family has no real way to pay for any unexpected event that comes up, such as an auto or home repair.  For people with a lot of high interest debt, however, sitting on top of money that could be used to prevent them from paying interest just doesn’t make sense.

Many people believe that they have to make a choice between paying off their debt and saving an emergency fund.  In fact, it is possible to do both, making it possible for a person to prepare for emergencies while making strides towards paying off high interest debt.

To do this, it is first necessary to come up with a basic budget that shows how much a person or family can contribute towards savings and paying off their debt.  Of course, this budget should include the minimum required amount for all loan payments.  After determining how much he or she can comfortably afford to put towards these two goals, it’s important to make a list of all the debts owed.  The list should include the payoff amount and interest rate for each loan.

Every month, a person or family should put half of the money they have allocated for their emergency fund and paying off debt into a special emergency fund.  This fund should be a simple savings account or money market account.  Unless significant amount of money has been saved, avoid putting money into long term investment such as a CD or bond fund.  While the interest rates on these accounts are better than those on most savings accounts, during an emergency it is important to have ready access to cash.  Placing money into long-term investment may mean not being able to access money or having to pay high penalty fees.

The remaining half of the money allocated to pay off debt and build an emergency fund should go towards paying off the highest interest debt that is owed.  Do not worry about the balance amount.  Putting everything towards highest interest debt ensures as little money as possible will go to paying interest and as much money as possible will go towards actually making a dent in the principal of the loan.  As soon as debt with the highest interest rate is paid off, take the money that was going towards this loan (including the minimum payment) and rework your budget so that this amount is now put towards your two goals.

For example, a person who has $500 a month to dedicate to savings and paying off debt should allocate $250 towards savings and $250 towards their debt with the highest interest rate.  Assuming the minimum payment on this debt is $50, this person or family would give $300 every month to paying off this debt.  Once this debt is paid off, the person or family will have $550 a month to spend towards these two goals.  In this case, they should allocate $275 towards their emergency fund and $275 towards paying off their next debt.


The article was written by Karl Stockton on behalf of Contact them in future to learn more about car insurance comparison.

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