Credit card debt increases every day that the debt is outstanding. Interest is calculated on a daily basis; so the longer you take to repay it the more it’s going to cost you. However, if you put all of your liquid cash toward debts, what happens if something comes up for which you need to make a major withdrawal?
Meanwhile, U.S. credit card debt has reached an all time high, as some 40 percent of Americans say they couldn’t cover an unexpected expense of $400.
So, is it better to have an emergency fund or pay off debt?
Paying Down Debt
The biggest reason to pay off debt first is the one we listed above. With credit card companies calculating interest on your average daily balance, you’ll save a lot of money if you pay off your debt as soon as possible.
Further, the lower your debt, the better your credit score will be. One of the determining factors of your credit score is the amount of money you owe in proportion to the amount of credit to which you have access. The less you owe in proportion to your credit limit, the better the risk you appear to be to lenders.
Further, debt can often get out of hand and consume larger and larger chunks of your take home pay. In situations such as these, it’s a good idea to consult a firm like Freedom Debt Relief and let them help you develop a plan of attack to get your debt back in check.
Creating an Emergency Fund
Life happens and with that, bad things could happen to good people. Jobs are lost. Accidents and illnesses occur. Pets get injured. Appliances break down. Roofs leak. Pipes burst. In short, all sorts of things happen that can saddle you with large unexpected expenses.
Most financial experts recommend having at least three to six months of your monthly expenses set aside in liquid cash (like a savings account or some other financial instrument you can access quickly without penalty) to cover such emergencies.
Furthermore, if you don’t have the cash on hand because you’ve been putting all of your money towards eradicating obligations, you’ll have to go right back into debt to resolve the situation.
So Which Comes First?
Simply said, neither and both come first.
In other words, the best play is to do both simultaneously. You have to hedge your bets. Relying solely upon a credit card to deal with emergency situations can be outrageously expensive as well as detrimental to your credit rating.
What’s more, you’ll be hosed if you’re close to your limits and don’t have enough credit to absorb the situation. Meanwhile, if you’ve been putting cash away for a rainy day, you’ll be in a better position to bargain your way through situations. All things being equal, the best move is to build the emergency fund first. However, you can’t overlook that ever increasing obligation credit card debt represents. Nor can you turn a blind eye to the fact that things often happen when you least expect them to do so.
Take stock of your income and measure it against your expenses. Look for ways to move things around so you can save even as you pay off your debt. As you develop your spending plan, you may find you’ve been spending on a lot of items more properly classified as “wants” rather than “needs”. Dialing back on those will help you do both. If things are really tight, look for a side hustle, a part time job, or scour your home for things of value you can sell that are just languishing in your closets and your garage.
With creative thinking and determination, you can accomplish both.