How To Prioritize Emergency Funds, Savings and Paying Off Debt

[MariP]

Apr 13, 2016 / By Zina Kumok 

We all want to be more responsible with our money. While that sounds great in theory, it can get confusing once you start to break things down. Emergency funds, savings funds and debt all need to be addressed regularly, but trying to figure out a consistent method leaves some paralyzed with indecision.

One of the problems that tends to trip people up is prioritization. Allocating your finances to the right place is crucial, but how do you decide how much to put towards any one purpose? How can you cut through the confusion and get your finances on the right track?

Read on for our tips.

 

1.   Save a Mini-Emergency Fund

 

You need to save at least a partial emergency fund first. If you don’t have one and have to face a crisis, you’ll probably need to borrow the money. That means you’ll end up in more debt – whether you owe a family member or a credit card company.

A basic emergency fund should be around $1,000. That will cover minor emergencies like new tires after your car has a blowout on the highway, last-minute plane tickets to a funeral, or a brief ER visit.

Each time you deplete your emergency fund, halt any other debt-reducing or saving until you build it back up. Once you’re debt free, you can focus on building a more substantial emergency fund, covering between three to six month’s worth of expenses.

 

2.   Refinance Debt

 

Before you start paying off your debt, you should find other ways to reduce it. If you have high-interest credit card debt, do a balance transfer onto an account with a 0% offer. See if you can refinance to get a lower interest rate for your other debt, including car loans, mortgages and student loans.

When you refinance, make sure that your new loan doesn’t extend your terms. The longer your loan, the more you’ll pay in interest. You should use the refinance as an opportunity to save money, not spend more of it.

After you refinance, keep making the same payments you were previously. Doing so will shorten how quickly you pay off your debt without forcing you to make any changes to your lifestyle.

 

3.   Focus on Saving

 

The general rule of thumb is that you should put between 10-15% of your income towards retirement. While some people advocate for focusing all your efforts on debt payoff, putting money toward retirement now can save you money later.

Why? Because saving for retirement is designed to be a long-term approach, and the most important aspect of saving for retirement is time. The more time you spend saving, the more you’ll have – simple as that. That’s why putting a little bit away for 40 years is better than putting a lot away for 20.

“A 28 year-old that saves $5,000 a year into a retirement account – if they average 8% and retire at age 68 – should earn approximately $1,295,000,” said CFP Peter Creedon of Crystal Brook Advisors. “To match the $1,295,000, a 40 year old would have to contribute $13,583 a year until retirement if we use the above parameters.”

 

4. Create a Debt Payoff Plan

 

Once you’ve started saving for retirement, you should focus on becoming debt free and creating more money to throw at that debt. There are two ways to do this – lower your living expenses or increase your income.

You can increase your income by asking for a raise, finding a new job or starting a side gig. Working an extra 10 hours a week at $10 an hour will yield about $400 a month before taxes.

To decrease how much you need to live on, you should find areas of your budget that you can cut. Do you eat out too often or have a yoga studio membership that goes unused? Are you paying too much for car insurance or internet? Take the money that you cut from your budget and apply that to your debt payments.

You can pay off your debt with one of two strategies – the snowball or the avalanche method (more on that later this week).

Once you’ve paid off your debt, put the money you were spending on monthly payments and beef up your emergency fund. Now you’ll be saving for yourself and your future instead of paying off old debt.

Zina Kumok is a freelance writer specializing in personal finance. A former reporter, she has covered murder trials, the Final Four and everything in between. She has been featured in Lifehacker, DailyWorth and Time. Read about how she paid off $28,000 worth of student loans in three years at Debt Free After Three.

[Renada89]

I don't have any Emergency fund to pay off my debt

[Legoge47]

I suddenly had to buy a new water heater for my house. I have no emergency fund. Never been able to get one.

[Ashham77]

Great advice!

[right22b]

Start an emergency fund by putting as little as $25.00 a paycheck into a fireproof lock box at home or a savings account at the bank. Never, never, never use it unless it is a true emergency.

[Buckfan]

To pay off your debt make monthly payment plus next month's interest if you can this will help pay off your principal balance faster.  Don't put money in a bank savings account too many fees and very low interest, better bet is a Money Market account. I have been asked by many what is a Money Market Account? A Money Market Account is basically a savings account but earns higher interest rates. It's a good place to put an emergency fund in with at least 6 months of your monthly take home income into. Another great way to save is to start with a $1.00 or $5.00 every week and double that amount you have the next week for the entire year. Ex. $1.00 to $2.00 to $4.00 to $8.00 etc. 

[Alison]

This article is written for people who are still employed. We are retired and squeeze through each month financially. We have no emergency fund. In addition, we have no savings. Fortunately, the debt we are paying off is informal. It is to 'benefactors' but not to any companies. Our 'contract' is word of mouth and friendly. It is not on our credit report. 
At our age, life can be short and we wish to save for some pleasurable things in addition to covering for emergencies and debt pay off. We just can't seem to get over the hump of living barely from month to month.
We sure could use some suggestions. BTW we have around 800 plus credit scores.

[Ole]

A quick way to save up cash is to sock away $5 bills into a coffee can everytime you have one.  It is amazing how quick it adds up and you don't really miss it.  I typically save $ 600-700 per year doing this.  It can be a mini emergency fund.

[JRay]

https://www.daveramsey.com/dave-ramsey-7-baby-steps

[KristineS5]

Hi Renada89 - An emergency fund should not be used for anything... except an emergency. 

But what is considered an emergency you ask?  Your hot water tank suddenly quits working one morning and you need to buy a new one and replace it, or your child becomes ill late at night and you have to make an emergency trip to the hospital or a stand alone 24 hour Emergent Care facility, or your tire catches a nail and you need to buy a brand new tire because fix-a-flat won't work.  These are emergencies. 

The urgent need to pay off debt may feel like an emergency, but is isn't. If you want to pay off your debt as quickly as possible, 

1. create a zero-based budget where income - expenses = zero
2. as quick as you can save $1000 if married or $500 if single for a starter emergency fund
3. list your debts, least to greatest without regard for interest rate
4. throw all available money at the smallest debt while making minimum payments on the others
5. as soon as the smallest debt is paid off, take all that money and throw it at the next debt to pay it off as quickly as possible while continuing to make minimum payments on the others and so on. This is called a snowball effect. As debt begins to get paid off, momentum will pick up with downward speed like a snowball. 

At it's core, getting rid of debt and staying out of debt is mostly about behavior. 

[KristineS5]

@Alison 

Sorry to hear you are barely living month to month. Sadly, you are not alone. Statistically, 70% of Americans are in the same boat.  The good news is, you can change this. It is never to late to change or start something new. You can do it!

I don't know what age you are or anything else about your financial situation, but the same rules apply to you as to anyone else. One or both of two things must happen to accomplish your goal of saving for emergencies and savings in general, and paying off debt. 

Expenses must be cut. Income must increase.

Again, I do not know anything about your financial situation, but those two things apply across the board in general.  Here are some suggestions and while they may seem obvious, they bear being said:

Do you use credit cards? If so, I recommend you stop and pay cash for what you buy.

Do you have car payments you cannot afford? You may need to get rid of a car.

Is your mortgage and property tax or rent greater than 30% of your take home pay? Least desirable, but you may need to move

Do you dine out frequently or cook most of your meals at home?  Cooking at home is always cheaper

Do you impulse buy or buy things you want but don't need?  This will kill your ability to save as you want

Are you on a budget? Do you create a written (or electronic) budget every month before the beginning of the month where income minus expenses = zero? This is called a zero based budget. Your budget must balance at exactly zero.  This does not mean zero dollars in the bank. It means income and expenses match exactly. Trim all unnecessary expenses. What is necessary may be up for debate, but generally speaking the only things we need are shelter and utilities, food, basic clothing, and transportation.  I call these the four walls. Always make these your first priority in your budget. Always. Prioritize from there. 

Second, as quick as you can save $1000 for an emergency starter fund. Sell stuff you don't need, work a part-time job.

Third, list your debts least to greatest without regard to interest rate.  Take all available money from your streamlined budget and throw it at the smallest debt to pay it off while making minimum payments on the other debt.  When the first debt is paid, move to the second debt and throw all money at that debt while making minimum payments on the others. This is a debt snowball and will gain momentum as it rolls downhill. The psychological value of paying off debt will encourage you to push forward! 

The above works. I know because I've done it. Not saying it is easy, but if you are willing to make some sacrifices - most people do to accomplish their goals - you can do this!

[Deb T]

Perfect! Exactly how it works! Good post!

[Cairo]

I honestly had the hardest time saving for the longest time. Anytime that I noticed myself with anymore than $200 and I knew my next check was a few days away, I would blow that on whatever I felt "needed" or denied myself. Eventually, I found myself taking my tips, bundling them up, and putting them in a safe place. I wouldn't touch it unless it was an absolute emergency. The upside is that I managed to save over $1000 in a little iver 6 months. The downside, however, is that I never knew how much I had saved, which is never a good feeling. In the end, I've now picked up a second iob, a budget, and a new saving method: quarters. The reason I save my quarters is because in my line of work, people tell me to "keep the change" more often than not. After so many months of that, I managed to comfortably set aside another emergency fund that continues to grow without a noticeable change to my income/spending habits. I think everyone can find something to that effect that may just help them set a little aside when they can.

[KristineS5]

@Cairo  Good for you!  That is great to hear.

So much of what we choose to do with our money comes down to behavior.  And our behavior is more often than not driven by our emotions.  Good for you on choosing to be disciplined to save.  

[Alison]

These suggestions work better the younger a person is and the more gainfully employed a person is. Personally, for a senior living on a fixed, limited income who barely makes ends meet, I do not find most of these suggestions especially pertinent. For example, here are my specific reactions to your suggestions:
1. Save a mini emergency fund of $1,000. HOW CAN WE DO THAT?
These days $1,000. might as well be a million dollars. There are constant emergencies i.e. car repairs on our 2003 vehicle. We have to come up with loans for that. A new A/C unit was needed when we moved from a studio apt to a one bedroom. We actually had to seek assistance from a nonprofit community organization for that.
2. Fortunately, we do not have any debt that is official. We have an informal payment plan for services and purchases that we pay down monthly. So there is no need for us to refinance credit card debt.
3. Focus on  Saving
How can we save when we barely make ends meet on a monthly basis? I admit that we do make self-indulgent purchases. But they are small and one of the few pleasures we have in life. Even though it would be a good habit to save even $5-10/month, that will not take us very far. So we've opted for the short term pleasure of small purchases rather than the long term goal like investing in a hobby or taking a vacation.
4. Create A Debt Payoff Plan
As I mentioned in #2, we have our informal arrangement for a debt payoff plan. Although we have been diligent with it, I find that the suggestions your article makes are clearly for much younger people.
In conclusion, we were Middle Class, gainfully employed, living in a house, owning two cars free and clear, and having investments. Then 2008 came. We lost just about everything. As a result, we went 'from Middle Class to One Day From Homeless'. To find out more, go to our story in a a three eBook Amazon Kindle series, The Former Middle Class eBook Series.