Which Comes First? Saving an Emergency Fund or Paying off Debt?

We hear this question a lot: “Should I pay off my debt or save for emergencies?”

They’re both good goals, but which one is gooder, er, better? That’s a tricky one. Whenever you’re dealing with multiple financial goals, they all elbow for your attention (and your dollars). But there is a method to this madness, and that’s what I’d like to talk about today.

First, the Basics.

Before we can talk about saving for emergencies or crushing your debt to smithereens, there’s the matter of your basic needs:

Immediate Obligations

You have to cover your immediate obligations. These are things that:

  1. Are guaranteed to happen, and
  2. Repeat every month, like clockwork.

Typically, they’re expenses related to survival, like groceries, utilities and rent. Immediate obligations also include your minimum payments on debt. Once you’ve got those covered, you move on to …

True Expenses

True expenses are the purchases that:

  1. You know are coming, but
  2. You don’t necessarily know when.

True expenses include things like auto maintenance, trips to the hair salon and spending money for Christmas. You want to make sure you’re setting aside a little money each month so that you’re ready when these costs come up. Obviously, you have a little wiggle room here (gifts), but you can’t ignore these categories entirely (oil changes).

Why the Basics Matter So Much.

It’s easy to see why paying our monthly bills is the top priority. You need a roof over your head, and food to keep you alive. But what about those true expenses? It’s harder to put aside dollars for car repairs when your car seems totally fine—especially when you’re wrestling with debt!

The thing is, if you don’t fund your car repair category, now, it could (easily) lead to new debt. I’m not a sports guy, but a sportsing analogy is perfect here: Imagine a football team that’s really good at playing offense. I mean they’re killing it! But when it comes to their defense, the coach shrugs and says, “Meh, let’s just not put any players on the field.”

Well, they’re going to lose, right!? And that’s just the truth. The same is true with our money. You gotta play some defense (read: avoid new debt) before you’re ready to go on offense (read: pay off debt).

A summary for non-sportsers: If you’ve been throwing all of your money at your debt and your car breaks down, you’d be forced to use your credit card, again. And we don’t want that!

What About That Emergency Fund and Those Debts, Though?

If you think about it, your emergency fund is just another true expense—except you don’t know what it’s for. Murphy’s Law correctly reminds us that things will happen (we just don’t know when or how much they’ll cost). Maybe your new-ish car’s battery will bite the dust. Perhaps your route to work will require a new toll. Or, maybe, your crazy dog will impale herself with a stick (true story, my dog’s ok, thank you).

You do your best to save for your true expenses, but you have to be ready for the curveballs. Wait, do you hear that drumroll? Anyone? Because …

Your emergency fund should come first! You heard that right, debt—we’ll deal with you later (soon, but later).

Now, I’m not saying that you have to save up a $10,000 emergency fund before you can get after your debt. Like other true expenses, just pick an amount that seems reasonable for you, and start budgeting for emergencies every month.

So, if you’re paying attention, you budget in this order:

  1. Immediate obligations (like rent or minimum debt payments)
  2. True expenses (like car repairs or gifts)
  3. Emergency fund (you decide the right size, based on your life!)

And that leaves us with debt payments. Any money that you have left after you’ve covered these three buckets should go towards your debt!

The best part of this approach? Because you’re budgeting for your true expenses (can I say “car repair” again?) you’ll be much better prepared, and you won’t have nearly as many financial “emergencies.”

And your stress levels about money will fall dramatically.

Interesting, but What About Interest?

Some of you might be thinking, “Ben, a savings account pays practically nothing, and my credit card charges me 18 percent interest! Doesn’t it make sense to pay off the debt, first?”

The answer is yes, but only from a purely mathematical standpoint. You’ll probably save more money by paying off your high-interest debt, first, but math isn’t the only guidepost. You have to weigh in risk—remember our defenseless football team? You really need to set aside money for those true expenses (and emergencies!), just in case.

Still, you don’t want to drown in interest payments, right? So, your best bet is to keep your emergency fund smallish—be as sparing as you’re able—and then go after your debt with all you’ve got!

Got Questions?

If you want to learn more be sure to drop into our free, online workshop called Create a Debt Plan. Our teachers would be happy to answer your questions.