It’s a classic financial dilemma: Should you build up an emergency account or pay off debt? Financial expert Dave Ramsey says you should pay off debt first, but only after you’ve saved up $1,000. Suze Orman agrees. But are they right?
Most experts disagree. Having a sizable emergency fund of three to six months’ worth of expenses can protect you from unexpected losses, including unemployment and medical emergencies. And these days, savers can build up their rainy day fund without worrying about growing their debt too much. Interest rates are at historic lows, and some debt repayments like student loans and mortgages are interest-free until the end of the year.
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We asked 17 certified financial planners which should come first: emergency savings or debt repayment. Here’s what they said.
Q: Should you build an emergency fund or pay off debt?
Why some experts think you should build an emergency fund first
“Emergency Fund! Ask anyone who's been laid off or furloughed if they would rather have money in a savings account right now or a lower balance on their credit card.”
— Christopher Woods, certified financial planner at LifePoint Financial Group
“The emergency fund comes first for two reasons. One, there are some things that you just can not put on a credit card. Two, studies have shown that people under duress make poor decisions with money due to the stress they are under. Having an emergency fund makes you feel more confident. It helps you to lower your financial stress, leading to better decisions.”
— Monica Dwyer, certified financial planner at Harvest Financial Advisors
Why some experts think you should pay off debt first
“If you are paying higher interest rates on the debt then [what you would make in interest] on the emergency fund, definitely pay off the debt. With the current low interest rates on savings, lean toward paying off the debt and consolidating debt to the lowest interest rate possible.”
— Mary Ballin, certified financial planner at Perigon Wealth
“If it’s credit card debt with a 19% to 21% interest rate, get rid of the debt and then immediately start the emergency fund. Perhaps put 80% toward the debit and 20% to the emergency fund.”
— Jon Haagen, certified financial planner at Ten Haagen Financial Services
Steps to building an emergency fund
- Calculate how much you need. Add up essential expenses and multiply them by the number of months you want to save. A good rule of thumb is three to six months’ worth of expenses —but you may want to consider 12 months.
- Set a savings goal. Break down your goal into smaller steps and figure out what saving schedule works for you. Commit to contributing the funds you’ve set aside until you reach your goal.
- Cut back on small purchases. This could be anything from a daily coffee habit to an unused subscription.
- Or make a larger money move. Interest rates are at a historic low — consider refinancing your home, which can save hundreds (or thousands) a year.
- Automate. Set up automatic transfers to direct funds into your savings account, taking the guesswork and scheduling out of the equation.
- Save your tax refund (and other windfalls). Whenever you receive income beyond your usual paycheck use it to beef up your emergency savings fund or get closer to your goal.
- Adjust your savings goal if needed. Check in each month. Are you on track to meet your goal? If not, consider adjusting to add more.
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Image: Nastia Kobzarenko