Pay Down Debt or Build An Emergency Fund First? Expert Help

Claire Hunsaker
Claire Hunsaker

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This question is one of the most critical in personal finance. It’s “live or die” territory. We will cover the how of setting up an emergency fund or paying off your debt elsewhere. This post Is all about strategy –  which do you do first?

Before we jump in, if this question is hot for you right now, I hope we can help. I know what it’s like to  have $9 in my checking account, and I haven’t always made the best decisions with debt. There’s no shame in making mistakes, recovering from an emergency, getting out of an abusive home or having low income and finding it hard to get ahead. We are here to support you!

What The Experts Say – Pay Down Debt

Most financial planners will tell you to either focus on the debt, or to build a “baby” emergency fund, then focus on the debt  and the fund simultaneously.  Why? Two reasons: 

  1. Debt is expensive, because you pay interest on it.  The longer you take to pay it and the more you defer it, the more interest you end up paying in the long run. Debt can really suck you dry. 
  2. Poor debt management impacts in other parts of your financial life. Your credit score dictates a lot of your financial flexibility, and required debt payments can take a huge bite out of your take home pay.

These well-intentioned experts are focused on long-term financial health. Paying down debt is absolutely crucial to your financial well-being. But whether to pay down debt or build an emergency fund is not a long-term question. It is a very short-term question, and one that gets asked when the poo poo is already flying from the fan.

Desperate Times Call For Desperate Measures

The financial experts are also making a privileged assumption: If the poo poo starts to fly, and you don’t have an emergency fund, that you can get money from… somewhere. Probably, your credit cards. They assume your credit card offers cash advances, is in good standing and it is not maxed out. And they assume the amount available is useful. These are all privileged assumptions.

You Can’t Conjure Cash Out Of Thin Air

In reality, cash is expensive in a crisis. If you have no credit card debt and no emergency fund, you have expensive debt waiting to happen. Whether it’s coming from an unsecured loan, your credit cards, friends or family, or a HELOC, the interest on that debt is high. 

You might have to sell valuable possessions. You might have to pillage retirement savings (presuming you have them) and pay the tax penalties. Loan shark and payday loans can have up to 400% interest.  The cost of emergency cash is extraordinary – either because the interest rate is high or because you owe people you love money. That has a real cost in your relationships.

The reason I promote the emergency fund first: you can go into forbearance with your debt, but you can’t conjure cash out of thin air.

Flossie Says: Build Your Emergency Fund First

Your emergency fund will not make you rich. You will not get any pleasure from it. It’s purely a safety net. The most important thing is that this money is available immediately, for free, no fees. Put away whatever you can into a separate account, preferably at a separate bank, so your brain knows this is Untouchable Money. Check out our list of common mistakes that could put you in financial risk. Hint, hint – don’t touch your emergency fund. You can read more about how to build an emergency fund here.

You may find it disheartening to watch your savings grow when they’re very, very little. Emergency accounts are not exciting and looking at one with $50 in it might just depress you. This is normal! Find a way to reinforce yourself and stay strong. If you have a friend in a similar situation, form a savings pact. If you have a partner, make it a plan you do together. Find someone who can support you and hold you accountable, and tap this person for a call every week. Or join us in the Flossie Community for free advice. 

Also, set some time every week to look at your automatic deposit history to that account, tell yourself good job and treat yourself. Read more about treating yourself while meeting your financial goals. 

When To Pay Down Debt

In a few, rare situations, debt paydown should be priority. If your debt is so expensive it will take over your life without immediate action, it should be a priority.That’s also true if you have guaranteed income that takes the pressure off the need for an emergency fund. Focus on your debt if:

  • Your debt is extremely expensive, you cannot get forbearance on it. Payday loans would be a culprit here.
  • Your debt is about to lose you an important asset, like your car. This is only for assets that help you make money. 
  • You have guaranteed income to cover your basic living expenses, such as a pension, Social Security, or alimony. They should cover all your required expenses and your dependents. 
  • You do not pay any of your living expenses. However, this one is a maybe. It’s inherently risky to rely on partners, parents, or institutions for your basic security. A small emergency fund that allows you to get out of your situation quickly is probably still a good idea.

Manage Your Debt While Building Your Emergency Fund

While you build your safety net, debt management is still an incredibly important part of your financial security. Here are some tips for managing your debt while focus on your emergency fund:

  • Call all of your lenders and request forbearance. If 2020 taught us anything, it’s that lenders will work with debtors in extraordinary circumstances. The earlier you call them, the easier it is to get wiggle room. They will probably not make it an awkward conversation, and they have talked with thousands of people in your shoes, so don’t be afraid to call. 
  • Make sure to continue your minimum payments. If you can’t get forbearance, you can discuss minimum payments with your lender. Student loans, banks, and credit cards offer many payment structures. You can use these payment structures strategically. Find out what is available to you!
  • Ask your lender “what is the minimum payment that will prevent interest from capitalizing?”  Capitalizing means interest that is added to the balance of your loan, and then you pay interest on that interest. This leads your debt to snowball into an amount you can’t pay off. It is a real thing that happens! Make sure to pay more than the amount they tell you, so you’re not increasing your debt. 

Finally, just remember there is no shame in your game. Many, many people have been to the brink financially. We’re here to support you, so hop in with your questions and we’ll give you a hand!

Join our AskFlossie community where all women are empowered with community and knowledge to build stronger financial lives. 

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