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I have something really important to tell you about saving for an emergency fund. I’ve been hesitating to write about it because it’s one of the more controversial opinions that I hold but I think you guys are cool enough to handle it.
Are you ready for it?
I think paying off debt can be more important than saving for an emergency fund
“WHAAAAAAT?” I can hear you saying already. “But everyone says I need to -save at least a $1000- before doing anything else!” Poppycock. One size fits all plans are rarely the best thing for everyone. There is always another way.
The Debt Payoff Emergency Fund Plan
The basics of this plan are simple with just a few tweaks needed to your budget.
Every month, in addition to paying your minimum balances, you will be paying an additional amount (however you much you can afford to budget) towards paying down your debt. I would suggest paying this towards your lowest balance first to knock out your minimum payment amounts as soon as possible.
The goal is twofold
- To lower your non-negotiable expenses as much as possible
- To increase the amount of credit available to you to draw on
Both in the case of unexpected unemployment or income loss.
If a financial emergency does come up, you will have credit available to use either by putting it on the credit card or by using the cash withdrawal feature that most credit cards have (generally at a higher interest rate but still manageable with your payoff plan).
Why is the Debt Payoff Emergency Fund Plan a good idea?
The credit card debt of the average debt-holding American household is almost $16,000. $16,000.
Assuming a very unlikely interest rate of 10% that’s still $1600 a year in interest. However, most of that credit card debt is likely carrying an interest rate of 15-20%, or even as high as 29.99%.
Paying down your balances comes with a number of perks, including:
Reducing Your Monthly Expenses
In a financial emergency, the fewer non-discretionary monthly expenses you have the better. By paying down and off completely your debt you lower the amount you need to pay per month in minimum payments. This also increases the amount you can pay towards your debt during non-emergency times.
Raises Your Credit Score
By paying down your debt you increase your credit available and reduce your debt-to-credit ratio. Both of these things play a part in determining your credit score.
This is especially helpful in a financial emergency if you need to open a new credit line to pay for the emergency. *SIDE NOTE: While increasing the amount of credit available is good for your credit score, running up the balance on your new card and leaving it for months is not. If you need to open a new line of credit to cover an emergency, add this to your payoff plan and work towards zeroing it out as soon as possible.
A higher credit score would also help you open a new credit card with a free balance transfer and no interest for 12-months (a common offer). This would help to reduce your pay down your balances faster and reduce your monthly expenses as well.
A More Stable Financial Footing
By using your credit as a financial safety net, you are keeping your remaining debt at the front of your mind in a positive way. Instead of your card balances being “somewhat high but manageable” you know exactly how much you owe and you have a plan for how you’re going to pay it down.
Puts Your Money To Work
The typical savings account only has an interest rate of 0.01%APY. There are some savings accounts that offer higher but those generally top out at still less than 1%APY. By contrast, the average credit card has an interest rate of 16.15%
By keeping your money “safely” locked away in a savings account, you are letting it take an undeserved snooze. Every dollar you put towards your debt is working 16% harder for you than the dollar you put in savings. Make your money work for you so you don’t have to work so hard later.
This Plan is not for everyone
This plan is not for the faint of heart. It takes a real commitment to your payoff plan. If you are the type to run up your balances as soon as you pay them (out of necessity or not), then this form of emergency fund will not work for you. That’s one of the reasons this is such a controversial plan.
The ideal candidate for this type of emergency fund is someone who has a moderate amount of credit card debt but is otherwise financially stable.
If your credit is already maxed out and your income is unreliable, then you may be better served with a traditional emergency fund and a budget that guides you towards paying down your debt as you are able. There is absolutely no shame in that. It’s what I’ve done for years and recommended to many of my friends and family.
But, if you feel like you are ready and able to try something out of the norm, the debt payoff emergency fund plan might be for you.
So buck the traditional and get saving for the future like an adventurer.