Enter your email to receive the FREE Money Hero Personal Finance eBook!
The question of whether to save money or pay off debt is a common one that many people face. It can be a tough choice to make. Fortunately, I have a solution for you: Do a little bit of both.
Let’s say you owe $5,000 in credit card debt, and have no savings. We all know that having a healthy emergency fund of 3 to 6 months worth of expenses can be a life saver that will help to keep you from going back into debt in case of an emergency. However, you don’t want to have that debt sitting there while you save, because interest fees can be a killer each month.
Save up a temporary emergency fund
So, start with a smaller emergency fund, then focus your efforts to paying off your debts. Experts recommend starting with an emergency fund of $1,000. This is a good amount for most minor emergencies, such as an unexpected car repair or doctor’s visit.
Once you’ve been able to save this amount, start paying off your debt. Use either the snowball method or the avalanche method to pay off your debts as quickly as possible.
Pay off high-interest debt
If you have multiple types of debt, such as credit cards and student loans, start with the debt with the highest interest rates. So if you owe $5000 in credit card debt at 26% and $20,000 in student loans at 5%, focus on tackling your credit cards first.
Longer term, lower interest debts such as student loans and car loans are not as dire as higher interest debt such as credit cards. Generally, for anything under 5%, you can take your time with.
Finish your emergency fund
After paying off all high-interest debt (anything over 5%), go back to socking money away in your emergency fund. At this point, finish saving up 3 to 6 months worth of expenses. This will be extremely important in case of a major emergency, such as a job loss. When you get your emergency fund up to the desired amount, you can then start to focus on lower-interest debt.