Should You Pay Off Debt or Save for Emergencies First? Experts Say You Can Do Both

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Deciding whether to pay off debt or save for an emergency is an important choice to make, but you might be able to do both.

Since the pandemic’s start in March 2020, 42% of credit card holders who already had debt have seen the amount grow, according to a September 2021 Bankrate survey of 2,400 U.S. adults. Meanwhile, only 4 in 10 Americans have enough savings to cover an unplanned expense of $1,000, according to a separate Bankrate survey from January. Bankrate, like NextAdvisor, is owned by Red Ventures.

The most important thing is to take an honest look at your financial situation and then put helpful habits in place immediately, according to two experts we talked to. Here’s what you should keep in mind as you make your own plan.

What to Consider When Deciding 

You want to look at the interest rate on your debt and allocate your cash accordingly, says certified financial planner and financial psychologist Brad Klontz. If your rate is low, you could split 50/50 between debt payoff and emergency savings, and if it’s high, you could do 90/10 with a focus on debt. “When the habit’s in place, you can then shift how much money you’re putting in each direction, but you’ve set all the pipelines up,” says Klontz.

At the same time, you want to do what makes you feel successful on your debt-payoff journey, says Summer Red, AFC®, education senior manager at Association for Financial Counseling and Planning Education. “I would probably have less emergency savings so that I could pay off that debt faster,” she says. 

When You Should Build an Emergency Fund First

Ideally, you would have at least a baseline emergency fund, but if you don’t have any emergency savings at all, it’s a good idea to save some money right away. While experts generally recommend at least three months, you don’t necessarily need that immediately. Start by saving enough money to help cover an unplanned expense like a car or home repair, or a big medical bill. “Then it might be time to approach paying down debt,” says Red. 

Once you’ve saved some money for emergencies, take care to leave it untouched and only for emergencies. “If you’re not maintaining your car, so it breaks down every other month, you might be using your emergency fund for something that may not be strictly speaking an emergency,” says Red. Instead, you can add up the recurring expenses, such as birthdays or oil changes, divide by 12, and save that amount every month, she says. 

The goal is to start putting money away regularly, no matter how small the amount. “For some people, $100, that’s not much. In a year or two, it’s a substantial amount of money,” says Klontz.

Can You Build Savings and Pay Off Debt at the Same Time?

Setting up both pipelines helps start the process. “I’m a strong advocate of doing it all right now, not waiting,” says Klontz, adding that too many people put off saving while they pay off debt. “Because life goes on and you didn’t set up that account.”

Pro Tip

Automating your debt payments and savings can help you avoid late fees and grow your emergency fund.

After you’ve secured your baseline, you can steer more money toward debt payoff. Interest rates are another thing to keep in mind, says Red. The interest rate on your debt is likely much higher than the interest you’ll earn from a savings account. In other words, you’ll likely pay more in interest owed on your debt than you’ll earn in interest on your savings, says Red.

You can also consider a balance transfer card to help you pay less interest on your credit cards and leave you more cash for emergencies. A balance transfer card will let you consolidate higher-interest debt onto a single new card that has a 0% interest rate on transferred balance for 12 months or more, depending on the card.

Before opening and using a balance transfer card, make sure you have a plan in place to pay down the balance before the promotional interest rate expires. Otherwise, you could end up in another debt cycle when the higher normal interest rate kicks in.

How Much Should Be in Your Emergency Fund?

Experts commonly suggest you have three to six months of living expenses in your emergency fund. “It used to be pretty consistently three months before 2008, and then we had a devastating blow to the economy, and that’s when it stretched,” says Red.

Of course, how much you’ll need depends on whether it must be used for something smaller like a basic car repair, or something more traumatizing like a job loss. “If you’re in a field that there’s only a certain number of positions or if you’re extremely highly paid, it can be hard to be able to replace that income, and you might want a little bit more padding there,” says Red. 

For longer-term financial emergency scenarios, consider an adjusted budget that cuts down your spending to only essential living expenses. To figure out an emergency fund that works in that scenario, you can cut out spending like streaming subscriptions, clothes, or other discretionary spending until you are on stronger footing.

You’ll also want to consider your levels of anxiety and security, and whether they are hindering your quality of life. “How important is it to you to have an emergency fund, on an emotional level?” says Klontz.

Ways to Tackle Debt Faster

Look at your spending habits

Paying down debt starts with looking at how the debt happened so you’re not just putting a Band-Aid on the problem, says Klontz. “What’s the mindset? What were the events? How did you get here?” he says. “If you don’t figure out how you got there, and how to stop the bleeding and how to heal whatever it is, you’re going to end up there again.”

This is especially true considering that many people have some tendency that impedes their efforts, such as buying things on sale that they don’t really need, says Red. “‘Do you see this, it’s 8% off?’ And it’s like, ‘OK, that dress is lovely, but you have four closets full of dresses with the tags still on. Have you tried to pay off your credit cards?’” she says.

Snowball vs. avalanche methods

Being able to cover the minimum on your debts is essential to avoid fees, and after that you have some choices. Tackling the smallest debt first and then rolling your cash toward the next lowest debt is called the snowball method, and paying off the debt with the highest interest rate first is called the avalanche method

While prioritizing the debt with the highest interest rate will cost you the least, it’s about what encourages you to stick to a plan. “If you’re somebody who’s driven by saving every possible penny, go with interest rate first,” says Red. “If you’re somebody who’s struggled to pay your debt off for a long time, maybe just getting one paid off will be really satisfying and help you keep going.”

Automate your payments and savings

Setting up automatic payments can also help you reach your goals. “That’s where the magic happens because you’ll forget about it,” says Klontz, who says people have a tendency to keep things as they are. “You’ll go back to your status quo bias, and before you know it you’ve made major progress on those goals.”

Canceling an automated gym membership, for example, is hard because you have to admit that you don’t prioritize your health, says Klontz. But when you automate something that’s working for you, the status quo bias helps. “If you’ve set up an emergency fund or a college savings fund, the mental energy you have to do is go in and say, ‘I’m going to rob from my child’s college fund,” he says. “Picture the goal. When there is no goal, the money disappears,” says Klontz.

Automating your debt payments also helps you avoid late fees, and you can reward yourself after you’ve paid off a debt or received extra income like a tax refund or a bonus at work. “Use part of it for something fun but then use the rest for financial goals,” says Red.