If you are used to dedicating your income to paying down student loans, credit cards, and other debts, it can be tempting to stick with it even when the economy takes a downturn. Habits are powerful, and debt is the kind of burden everyone is eager to unload. Yet, if you have to choose between paying off debt and building up your savings and emergency fund, it may be time to rethink that strategy.
Experian’s 2019 Consumer Debt Study revealed the average debt in America reached new highs, totaling $14.1 trillion. A combination of student loans, mortgages, credit card balances, home equity lines of credit, and more have weighed down consumers in every generation. Therefore, it makes sense that many people prefer lessening their debt burdens before putting away any extra money for themselves.
However, having an emergency fund saved away is just as important as lowering debt. The question for many people is which goal to prioritize: paying off debt or saving for an unforeseen emergency? One may make more sense than the other, depending on your specific financial situation.
While the average debt in America has grown for most consumers, many people still make saving money a priority. If their loan rates and/or balances are typically low, then their debt may not be so crushing that it outweighs the need (and ability) to save money. They might also save as part of a retirement plan offered through their employers, building a future nest egg without having to think about it. When employers match contributions, even better — it is smart to save at least as much as the employer will match.
When interest rates are high, saving money is much more of a challenge. Paying off debts with the highest interest can make managing your money easier, and finding ways to cut those rates by applying to balance transfer offers for credit cards or asking to refinance at lower rates could save you more than the interest earned on a savings account.
Still, this does not mean that every spare dollar you earn should go toward lowering debt. An emergency savings fund addresses the equal burden of covering monthly expenses should you lose income for a few months. Experts recommend aiming to save enough for at least three months of expenses at first and suggest a fully stocked emergency fund should carry you for at least six to eight months.
Your monthly expenses are unique, so it will be up to you to set realistic goals. Decide what monthly expenses are essential and what luxuries are worth budgeting for, then make a plan that you are comfortable with. Most importantly, do not allow yourself to become stressed if you have to use some of the fund for an emergency and must work your way back up to the same goal again.
When you start prioritizing paying off debts, the totality of it all can seem overwhelming. But several strategies can make debt repayment easier to manage. For example, you can prioritize each debt by its interest rate, paying off the credit cards and loans with the highest rates first. This may have a bigger positive impact on your finances than the interest rates you would gain on the average savings account.
Another option is to consider prioritizing by balances. Paying off your smallest debt might not make as big an impact long-term, but the encouragement of paying off a debt in full and having one less item to worry about can motivate you to knock out each debt one by one. The key is choosing a strategy that is easy to stick to and makes it possible to continue building your savings. It can help to treat your savings account as your first bill to pay off, which builds a habit of prioritizing paying yourself before anything else.
Whether you are new to savings, paying off debt, or both, take time to plan your priorities. Take your entire financial health into account, including last-resort options such as family members you can rely on in case of emergencies you cannot handle. Also, speak to a financial advisor about tracking your expenses, income, debt, and savings. The best strategy is to balance savings and debt reduction, and you will need a system of tracking all your finances to do so successfully.
This article does not constitute legal, accounting or other professional advice. Although the information contained herein is intended to be accurate, Cathay Bank does not assume liability for loss or damage due to reliance on such information.