Should you pay off debt or save money for emergencies? This question often comes up about personal finance. The answer really isn’t just as simply one or the other as some supposed financial experts claim. There is a lot more that goes into deciding to pay off debt or saving for unexpected emergencies.
When it comes to deciding on saving for emergencies or paying off debt it is important to evaluate the situation each person is in. Moreover, it is imperative to look at the debt that needs to be paid off. Even with keeping these in mind, the fundamental answer to debt payoff or saving for emergencies is to have a great balance of both. Just doing only one or the other is almost always not the best answer.
It’s essential to both save money for emergencies and pay off debt. Don’t just focus on one of these goals at a time. Both need to be achieved and finding a balance between saving money and paying debt is almost always the best solution financially.
Why is it important to find a balance between paying off debts and saving money for emergencies?
Achieving a balance in debt payoff and saving money is important because only focusing on one or the other only is likely to be a problem. It might seem to make sense to snowball all your debt starting with the smallest to largest without saving any money in between. Maybe saving 6 months’ worth of expenses might appear to make more sense while just making minimum debt payments.
It is important to balance debt and savings because there is always life and the unknown. Employment can change. The economy can also shift in a different direction at a moment’s notice. The recent Coronavirus should have taught everyone a lesson about the unexpected. Therefore, it is important to be financially prepared for unforeseen bumps in the road.
Paying only debt off and not saving for emergencies might not help in an unexpected financial change.
It is never a completely bad idea to pay down debts. This can be particularly the case with high-interest credit cards. The problem with only paying debt and not saving money is what happens if an emergency comes up? With credit cards paid off, they could just be used again at a high-interest rate. At least money was saved in the time the debts were paid. However, what about using all your money to pay off student loans or an auto loan?
Focusing on certain types of debt to completely pay them off while not saving money leaves a person with no access to cash should the unexpected happen. If someone uses most of their earnings to pay student loans, this will not provide a benefit for cash flow. Vehicles depreciate at a rapid rate. For someone that uses a large portion of what they earn to pay for a car, what will this provide in a time when some extra money is needed? An automobile could be sold if there is much money left in it. However, there will likely be a loss. Cars on average depreciate in value as much as 55% after just five years.
Paying off the debt of depreciating assets using everything a person has financially does not provide the money that might be needed in an emergency.
Employment changes and job loss are not a matter of if it will happen but when.
One of the largest reasons to not work on just paying down debt but to also save for emergencies is the likelihood of losing a job or having the need to move to another one voluntarily. According to the Bureau of Labor Statistics, the average worker will have ten different jobs before age 40. This number is projected to only get bigger. Today’s younger workers will likely have 12 to 15 different jobs in their lifetime with the possibility of a career change or two.
Employer loyalty today is at an all-time low in comparison to decades ago. Employees are many times looked at as being expendable. The global business world of today with the fast pace of technology makes job security a thing of the past for a growing number of people. Firings, layoffs, buyouts, and mergers are commonplace. This leaves most people in the workplace in the position of being eliminated at any time.
It’s important to save money for a change in employment not just for being let go involuntary. Today, many workers wanting to advance their careers need to switch jobs. This might require a brief period of not getting a paycheck.
Changing an employer might also not be to just advance a career or due to a layoff. The corporate world of today is one where the employees often work more with less. Stressful working conditions and working for unpleasant people are not uncommon. Finding a new job or leaving one without having a new employer could be a possibility to ensure a person’s health physically or mentally.
Don’t delay saving money to pay off debt.
Although many financial experts would argue that paying off debt would be a priority as opposed to saving, this isn’t always the case and there are certain situations where it makes sense to put money away.
Low-Interest Debt
Paying off high-interest debt, such as credit cards, should be a priority while saving. However, it can make sense to save more money over paying debts when the debts have a low-interest rate. For example, a student loan with a 5% rate shouldn’t be a priority to put every penny into paying it off when there is no money saved for job loss and emergencies.
There is no question that student loan debt can be a challenge to one day pay off. However, in the case of federal student loans, there are options available to suspend or lower payments with the loss of a job. With the average student loan today over $30,000, higher education debt is common. But depending on the interest rate it should not be the only priority.
Waiting to be debt-free to save for retirement should not always be an option.
Although paying off debt is always a priority, there are situations with retirement savings where it does not make sense to delay contributions. For someone that has access to an employer 401k with matching contributions, it doesn’t make sense to give away free money. If for example, an employer will match up to 5%, then put in at least 5% of earnings to get this money.
When it comes to saving for retirement compound interest and time are valuable assets. Avoiding retirement savings completely in order to become debt-free is not always the best choice. Saving for retirement is one of the most important financial goals for most people and it is important to have a plan and save.
Pay off the mortgage or save for emergencies?
For people that have debt and a mortgage, there are financial professionals that would advise paying off a home early. A mortgage is a debt. Yet, most homeowners do see some appreciation in the value of their homes. Add this to the low-interest rates today and paying off a mortgage while not saving money for emergencies is generally not a good idea.
Homeowners that have equity in their home will claim they can access this in an emergency. However, this money does come at a cost even if it is at a low-interest rate.
When it comes to job loss and emergencies every person will still need a place to live. This will either include a mortgage payment or rent. Paying off a mortgage payment or switching to a 15-year loan to pay a home off early is not always the best choice to plan for emergencies.
Having a job loss and emergency fund should include the cash that is easily accessible. A home could be sold in a difficult financial situation but you can’t time the sale to the market. Home prices might be up or down. Furthermore, selling a home does not solve the problem of needing a place to live.
If you own a home, you should balance saving for emergencies and paying a mortgage. Getting a home equity line of credit can be a challenge without a job. It’s important to have money set aside.
Even though a 15-year mortgage typically offers a lower interest rate, a 30-year term can offer more cash flow to save for emergencies. A 30-year mortgage with no prepayment penalty allows a home to be paid off early while allowing flexibility and saving for the unknown.
There should be a balance between paying off debt and saving for emergencies but one can be a priority.
It is important to find a balance between paying off debt and saving for emergencies. Both should really be done at the same time but there can be reasons for one to take priority with a little more money over the other.
Some of the top considerations for choosing to prioritize debt over savings include:
- What kind of debt is there and what is the interest rate?
- Is there already money saved for job loss and emergencies?
- How much money is saved for emergencies and retirement?
- Do you have any job security?
What should you do?
Deciding to pay off more debt or saving for emergencies really comes down to a personal decision. It also depends on how much money is already saved along with the debt that needs to be paid off. Finding a balance between saving and paying debt is really the key to success ensuring a level of financial security.
Although there are percentages and numbers that make sense with servicing debt or saving money, the truth is it is never the same for everyone. A supposed financial guru might claim 3 months of savings is good for emergencies. Yet, you might feel better with a year’s worth of money in the bank.
Paying debts highest to lowest of the highest interest debt first might be something you read in a book or hear on the radio. However, it’s important to realize that each situation does not fit the same. Balance is the key in life and money. Find the balance that works and particularly works for you.
