Sep 26, 2024
As you look to balance your finances, you may wonder if it’s better to create an emergency fund or pay off debt. Both are smart money moves that could help you achieve financial wellness. But the right move depends on your personal circumstances and what’s going on in your life.
In reality, you may not have to choose. This article offers strategies that may help you pay off high-interest debt and grow your savings at the same time.
An emergency fund is money you set aside to cover any financial surprises and leave untouched unless absolutely necessary.
Before you decide whether to pay down debt or build up your savings, it’s a good idea to protect yourself in case of financial emergencies. What if your car suddenly needs major repairs? Or if you're hurt in an accident, how will you pay the medical expenses? Where would you get the money to get by if you lost your job? These are just some examples of why you might need an emergency fund.
With many people unprepared for sudden financial challenges, understanding the importance of having some money saved up is crucial.
If your emergency fund hasn't been your top priority, you're not alone. More than half of Americans say they don’t have any emergency savings. Without emergency savings, you may be forced to tap credit cards or other high-interest loans. That could increase your debt load and undermine the financial security you’re working hard to achieve.
Experts recommend savings of three to six months of living expenses, depending on your personal situation. For example, if you’re self-employed, have a family with children, or rely on just one income to make ends meet, you might shoot for an emergency fund at the higher end of the range. But if you’re retired with a pension and live well below your means, a smaller emergency cushion might be enough.
Don’t worry if you don’t have three to six months of savings right now. Focus on taking small steps to build up whatever savings you can. Some savings is better than none and can put you on better financial footing in case of unexpected expenses.
Once you’ve made a commitment to pay off debt and save for the things that matter to you, you’ll want an easy way to budget for those goals.
The 50/30/20 rule offers a simple approach to budgeting and may help you start saving. Paying off debt and saving are built into the system. Here’s how it works.
Even saving as little as $50 or $100 a month may help put you on a path toward financial security.
When it comes to saving, don’t forget to take advantage of your company’s 401(k) retirement plan, if it has one, to save in a tax-friendly way. You’ll want to contribute enough to maximize any matching funds your employer offers; that’s free money, and it’s a good idea to take advantage of it. If you have any questions, be sure to consult a tax professional or your company’s benefits counselor.
You can look at other approaches to building your savings, like automating saving or taking on some freelance work to bring in additional income. Whatever you choose, think about sharing your goals with a friend and asking them to help you stick to the plan.
After you’ve made a decision about emergency savings, you can start getting more aggressive about paying off your debt. Even if you're keeping up with monthly payments, chipping away at higher-interest debt can go a long way toward improving your financial health.
There are several reasons why focusing on your debt is a good idea.
The importance of paying off debt depends on the types of loans you have and how much of your budget they take up. You might have higher-interest credit card debt, medical debt, student loans, or a mortgage.
First, identify all of your debt and look at your balances and the interest rates you’re paying. You can then decide which debts to pay off first. Once you have all that information in one place, consider whether you want to follow the snowball or the avalanche approach. With the first approach you handle your debt with the smaller balances first. The other approach has you focus on your highest-interest debt first. The best method depends on your personal situation.
For example, if you have a payday loan you might want to tackle that one first. While typical payday loans involve borrowing small amounts, the steep finance charges and penalties can add up fast, so it may benefit you to get rid of it as quickly as you can.
Another approach may be to consolidate your higher-interest debt with a personal loan. You might be able to get a lower interest rate, which could create more breathing room in your budget and provide peace of mind. It’s worth noting that 84% of surveyed debt consolidation customers told us taking out a Discover® personal loan gave them a sense of relief.*
What’s more, debt consolidation could give you a bit more control over your budget. Instead of multiple payments with balances that might vary from month to month, you will have one set regular monthly payment. And it's easier to budget for a fixed expense.
Consider an example in which you are paying off multiple creditors using credit cards, versus a single loan from Discover Personal Loans. Imagine you have a FICO®** Score of 720, a $5,000 balance on one card with a 19.99% APR, a $4,000 balance on a card with a 22.99% APR, and a $3,000 balance on a card with a 23.99% APR and were paying $100 each month on each card. If you apply and are approved for a Discover personal loan to consolidate that debt and get an estimated 17.99% APR, you could save $3,359 and pay off your debt 11 months sooner, depending on the terms of your offer.***
Addressing your debt offers an opportunity to re-evaluate your spending habits and prioritize financial goals. So how can you do that? The answer is different for everyone.
If you’re ready to tackle debt, then paying it down might be your top priority. Making strides toward reducing your debt and watching the balance decrease can be a big stress reliever. Once your debt feels more manageable, you may be able to rework your budget to prioritize savings.
Ideally, you should try to design a budget where you can save money and pay off debt at the same time. If your debts are manageable and you’ve shored up your emergency savings, then you can work on saving for other things that are important to you.
In the end, having a plan and consistently sticking to it is one of the best way to pay down your debt and build your savings.
Interested in learning what you might save in interest with a personal loan for debt consolidation? Use our calculator to estimate your potential savings with no impact to your credit score.
Articles may contain information from third parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third party or information.
The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to any obligation or liability whatsoever on the part of Discover Bank or its affiliates.
* ABOUT SURVEY
All figures are from an online customer survey conducted September 14 to October 3, 2023. A total of 1,191 Discover personal loan debt customers were interviewed about their most recent Discover personal loan with 550 of them using the funds to consolidate debt. All results @ a 95% confidence level. Respondents opened their personal loan between January and July 2023 for the purpose of consolidating debt. Agree includes respondents who ‘Somewhat Agree’ and ‘Strongly Agree’.
** FICO is a registered trademark of Fair Isaac Corporation in the United States and other countries.
*** This estimate maintains your current $300 monthly payment for a 62-month term at 17.99% APR with a total loan cost of $18,457. Rates are calculated based on Discover application data as of 8/12/2024.
