An emergency that requires a money injection may lurk just around the corner. Financial advisers recommend three to 12 months of expenses in an emergency fund in the event of job loss, repair costs or medical bills. Existing debts get larger unless you pay more than the interest charges each month, so you’ll want to get these debts paid. Choosing to pay debts or accumulate an emergency fund depends on the economy, interest rates, your access to credit and your comfort zone.
Some debts are fixed amounts and essential. You have no choice but to pay for your house, utilities, car payment and student loans if you want to keep using them. Debts are secured or unsecured. If you don’t pay on a secured debt, you lose the security, also called collateral. That includes your car or house purchase. Credit cards are unsecured debt with no collateral. You’ll need to pay the minimum payment on your credit cards and similar debts every month to keep a good credit score. If you’re only paying the minimum on credit cards, you aren’t really paying down your debt. You have a choice when it comes to paying extra on your credit cards or paying into an emergency fund. Set up an emergency fund bank account so you can’t use that as an excuse for not saving.
Interest on credit card debt is money you pay for using money. A cash emergency fund will not accrue comparable interest in a liquid bank account. You may be comparing 20 percent interest charged for your credit card to 1 percent credited to your emergency fund savings account. As the economy changes, interest rates and access to credit may affect your personal decisions. Simple math says to pay credit cards with the highest interest first, but financial experts suggest that you may get yourself in a financial pickle. If you have an emergency or lose your job and have no emergency fund, you may not have money to carry you through the crisis. Financial analyst Suze Orman reviewed her recommendations when the economy changed and layoffs increased. She suggested that the emergency fund should come before debt repayment.
Access to Emergency Money
If you have a credit card that hasn’t reached the limit, you may want to pay down your other debt and keep the credit card charge-free in case of emergency. If you use the credit card, you won’t have the full limit for use in an emergency and you’ll wreck your plans. You know how much will power you have and whether you can keep a charge card available for emergencies while you pay down your debt. This isn’t a permanent emergency fund because the card company is in control. You want an emergency fund that you can access on short notice and that you control. You’ll also break the debt cycle with an emergency fund and not rely on credit cards to get you out of a jam.
Building an Emergency Fund
Your emergency fund gives you flexibility in money management. When you pay money on your debts, that money is committed forever. When you pay money into your emergency fund, you can use it to pay the most important bills in an emergency. Even if you’re living on a financial cliff, you can still build an emergency fund while you pay down your debt. Windfall savings is one way to make this work. Any time you save money with coupons or do-it-yourself adventures, contribute the money you would have spent to your emergency fund. Overtime pay and rebates are windfall funds. Don’t forget credit card loyalty points that you can exchange for cash. Add any unexpected windfall or extra income to your emergency fund and enjoy the emotional security of available money. Once you have an emergency fund that will carry you through a car breakdown or a few days off work without pay, you might choose to divide your windfall money between your emergency fund and your debts. Real Simple suggests a 50/50 split until you get your debts paid.
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