An emergency fund is a financial buffer designed to ensure debt isn't the first choice when unexpected financial situations arise. But for people who are already in debt, does it still make sense to build an emergency fund?
What comes first? The debt paydown strategy or the emergency fund?
What factors should be considered when choosing to start an emergency fund or focus on debt?
As with most aspects of personal finance, deciding whether to pay down debt or start an emergency fund is a personal choice and depends on each individual's situation. That being said, there are a few things to consider before starting an emergency fund if debt is in the picture.
- Interest rates - If most debt is high-interest loans or credit cards, it may make sense to pay those first. Setting money aside for an emergency enhances financial security. But if someone is paying 15-20% interest on a credit card, it's tough to justify putting money aside that's not helping that cause.
- Remaining payments - If full debt repayment is only a few months away, it may make sense to continue on the current path as deviation may risk the existing debt paydown strategy. If repayment is years in the future, it may be prudent to put an emergency fund in place now.
- Emergency fund goal - While someone’s ultimate goal may be a $25,000 emergency fund, it's imperative to find a smaller base amount to begin. $500 or $1,000 can be a great starting point to give a confidence boost and added security without taking years to build up.
After someone fully understands the picture of their debt and how much of an emergency fund they want to build, it's time to decide which to do first. Below are the pros and cons of creating an emergency fund first vs. repaying debt first. It’s also possible to try and do both simultaneously, but people are often discouraged by seeing limited progress in each area.
Emergency Fund First
There’s a reason why many financial gurus first suggest creating a $1,000 emergency fund. While minimum debt payments will still be made, quickly creating a small buffer can protect against taking out future debt when something unexpected arises. If an emergency happens, use the fund and work to build it back up to a reasonable place before resuming debt paydown.
Debt Paydown First
In this strategy, the emergency fund is put on the back burner until debts are paid. Once debts are fully paid, all money previously going towards debts is used to quickly build an emergency fund.
No matter which strategy someone chooses, the important part is the understanding that both debt paydown and an emergency fund are critical to a healthy financial life. It's challenging to prioritize one over the other, but recognizing that both are necessary is a huge step in the right direction.
Notice: Information provided in this article is for informational purposes only. Consult your financial advisor about your financial circumstances.
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Original Source: Advance America: The Pros and Cons of Starting an Emergency Fund for People That Already Have Debt