Emergency fund vs. debt snowball: What’s the top priority?

emergency fund

A few weeks ago, in my review of Mary Hunt's Debt-Proof Your Marriage, I mentioned that she advocates building a 3-6 month emergency fund before beginning to snowball your debt payments. That's not my approach, and I criticized it a little in my review.

Several commenters said they agreed with Hunt — that an emergency fund should trump debt repayment. It's an interesting issue, so I figured I'd explore both sides of it in a little more depth.

The Case for an Emergency Fund

The primary case for an emergency fund is simple: Having savings helps you break the cycle of debt. When your car breaks down, you won't have to rely on a credit card to get your wheels back on the road. You'll have your own savings to fall back on.

There's also a more subtle reason to do it. Saving money is at least as much about your state of mind as it is about your income and expenses. If you can get into the habit of saving a chunk of your income — 10% to 20% is what most experts recommend — you'll be well on the road to financial health. Adopting the “pay yourself first” strategy is one of the keys to personal finance.

Treating your credit card bills like any other household expense while paying yourself first makes good psychological sense. But you'll pay for it with interest.

The Case for the Debt Snowball

If, instead of putting your eggs into your own basket, you pay off your debts faster, you pay less interest on those debts. Even the best high-interest savings account is unlikely to get you an interest rate anywhere close to what your credit card charges. Odds are good that the interest you pay on those card balances is a whole order of magnitude greater than the interest you earn on your savings.

Over your lifetime, that means you'll have more total money if you pay off the high-interest debt first and then build up your savings.

But that only works if you get out of debt and stay out of debt. If small emergencies force you to break out your plastic every couple of months, you may just be treading water instead of turning the tide.

Related >> Which Online High-Yield Savings Account is Best?

Taking the Middle Road

One good approach is to take a hybrid of these two: Build a small emergency fund first, and then pay down your debts as aggressively as possible. Dave Ramsey recommends putting $1,000 into savings before tackling debt. What you want is enough to cover a small emergency like a car repair or a plane ticket, but not a full 3-6 months of living expenses.

This is essentially what I did last year. I saved $1,000 in a savings account, and then began snowballing my debts. I also used the increase in our income after I returned to work to feed that debt snowball, and was able to repay a lot of debt fairly quickly.

Building up a small emergency fund and then aggressively paying off debts seems like a good middle road, but it's not without potholes.

At the beginning of our debt-payoff period, my husband and I weren't quite on the same page about our financial changes. Neither of us was used to living within our means. It was a great idea, but it took some practice to get good at tracking our spending and sticking to our budget. There were times we'd come up short at the end of the month.

Having a small emergency fund sitting there was like a fight waiting to happen. Couldn't we just take the money out of savings to cover this plane ticket? Or that gymnastics class? It turned out that, at the beginning of our debt repayment, we hadn't moved into the mindset of saving yet!

For us, paying off the debts faster and staying in the risky position of having no safety net worked better psychologically. Paying off debt was something we could agree on. And once the money had been sent to the credit card company, there was no bickering over what to do with it.

Related >>Real-Life Case Study: Should I Save Money or Pay Off Debt?

Handling Emergencies Without a Full Emergency Fund

You can't plan for emergencies; that's the nature of them. You can find creative ways to handle them, though. While my emergency fund hasn't grown beyond that initial $1,000, I've been able to handle all of the small emergencies that have come up in the past year without taking on any new debt.

One thing I've found is that, as my expenses have dropped and my income has increased, I have more money available. Most months, I use it to pay down our debts. When an unusual expense crops up, I can dip into my debt snowball to cover it. I've never had to touch our emergency fund yet.

This month, for example, my laptop needed major repairs. I could have tapped my emergency fund for the $300 to cover it, but instead I took it out of my regular checking account and simply scaled back my debt snowball a little (though not by $300; I also took money out of my entertainment budget to cover this).

Do What Works for You

Having a small savings fund to draw upon is definitely key to breaking the cycle of debt. You need to create enough of a buffer in your budget to absorb hits like car repairs, appliances breaking down, and health issues cropping up.

Beyond that, you need to do what works for you. If establishing the habit of “paying yourself first” is your top priority, setting up a weekly savings deposit and building that emergency fund might be your best course, even though it means paying a little more in interest over your lifetime.

If you're completely driven to get out of debt, you may do better to snowball your debts first and pay them off fast.

Ultimately, you need to do both: Eliminate your consumer debt and build an emergency fund. The order you do these steps in matters less than living out a commitment to establishing sound financial health.

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William Wallets
William Wallets
13 years ago

You’re right, it basically comes down to what works for you. However, if I were in your situation, I would aggressively pay down the credit card debt with pretty much all of the balance transfer money. This will save you money on interest charges. This saved money will make your budget less and less tight every month. Once you have paid off all the credit cards, then you can focus on getting the balance for your 0% credit card ready to be paid off. I caution you with this method though… If you don’t think you can pay off the… Read more »

Gaming Your Credit
Gaming Your Credit
13 years ago

Use the 0% to pay off all of your debts on which you are paying interest. As long as you are in debt and being charged interest at credit card rates, it makes little sense to save money in a bank. Your credit cards have been your “emergency fund” in the past, and they can serve that purpose again in the future. To put it mathematically: Chance that your credit cards will continue to charge interest for the next 12 months: 100% Chance that you will need an emergency fund in the next 12 months: less than 100% Pay off… Read more »

Kevin M
Kevin M
13 years ago

I’m not sure I’m understanding this correctly. You got a check for the amount of your credit limit on a credit card? If this is the case, you are essentially taking a 12 month loan that must be repaid within 12 months, right? Now the question becomes, would you borrow money to use as an emergency fund? I think the answer here is clearly a no. Whatever interest you would earn would be negligible. Pay off as much as you can on the credit cards. As William above mentions, this will cut your interest charges… which should give you breathing… Read more »

MillionDollarJourney.com
MillionDollarJourney.com
13 years ago

Have you also set a budget for yourself? Just the activity of writing down what you spend in the run of a month really opens up options on where you can save.

Also, you should look into getting a 2nd job if your primary income isn’t sufficient.

FT
http://www.MillionDollarJourney.com

samerwriter
samerwriter
13 years ago

I agree with the advice of putting some portion (perhaps $1000) in savings and using the rest to start paying off cards.

And don’t start relaxing when you have your current cards paid off. Until you’re able to repay Citibank’s loan to you, you’re still in trouble in 12 months.

You need to examine your expenses and find other ways to cut until you get out of the hole.

joshuat
joshuat
13 years ago

Build up an emergency fund first. You need a safety net while you’re paying off debt because “Life Happens”.

$1000 is a good recommended amount. Then pay off the debts, including this Citi card and build up a good sized emergency fund of about 6 months expenses. Get into the habit of saving up and paying cash for all purchases.

Remember, your emergency fund is for EMERGENCIES only. Its not for a PS3, school books, clothes or Christmas.

John
John
13 years ago

I’m in a similar situation–I have a ton of student loan and credit card debt from my days in school. Now I’m trying to pay down my credit cards (my student loans are consolidated with a very low interest rate), but I’d also like to have an emergency fund, but I don’t think I can do both at once. Because I’ve racked up so much debt, I’ll be paying for quite a while before I’ll notice any let up on the budget. So I’m thinking I should just pay the minimums until I can get a small emergency fund set… Read more »

Mike
Mike
13 years ago

Are you talking about putting money on a credit account that you will have to pay back (at zero percent if paid within a year)? If that’s the case, I would not use any of that money. If you are cutting it close as it is, I wouldn’t take on thousands of more (potentially) free debt in the hope that I could pay it back before the 12 months is up.

Am I misreading the question?

kc0dxh
kc0dxh
13 years ago

Emergency fund first! Here’s why:

1. The work required to establish the fund will be a deterrent to spending it frivolously. Credit cards do not have any work and so in turn have no deterrant.

2. An emergency fund is your buffer between Murphy’s law and sworn-off credit. To get out of credit, you have to stop using it.

3. It’s an easy success. This is encouraging.

Wesley
Wesley
13 years ago

I’ll vote for eliminating the debt first. The fear of not having a sizable safety net will keep you motivated to pay the debt off quickly. This may sound a bit cold, but if you’re having a tough time staying on course, removing cushions often helps. Think about what would truly get you in a bind, and make some provisons. For instance, go ahead and find a cheap mechanic in case you have car trouble. Prepare for anything that could keep you from working and paying the debt, and keep at it for a while! Good luck paying off the… Read more »

threadbndr(karla)
threadbndr(karla)
13 years ago

I’d pay off all interest-bearing debt with your balance transfers. Then put half the funds that you were paying on the card minimums into an emergency fund untill you get to the afore mentioned $1000. I wouldn’t borrow against the new card for that, though. Use the other half of your prior payments to get a “jump” on the CitBank card. Just because it’s %0 interest doesn’t mean it isn’t debt. I’d scrape around for other sources of income or savings to supplement both efforts. As tempting as it is to pull cash out of the new 0% card, resist.… Read more »

William Wallets
William Wallets
13 years ago

For the emergency fund supporters… I am not sure I understand the rationale completely. If an emergency comes up, why not just just use the free, 0% credit card to make the purchases? The cash is earning 6% while the credit card is charging a rate that is (much?) higher. The worst case scenario is that the debt only gets paid down a little since there is an emergency that happens in the next year. Then he’ll just have to roll the debt to another 0% card until he can pay that off. It looks as if the post’er is… Read more »

Kevin M
Kevin M
13 years ago

After reading the comments, I have to fully agree with William Wallets. Use the cards as a last resort emergency fund. Put it toward the debt, cut your expenses further, and continue to pay down the debt. Just don’t let that 12 month mark sneak up on you.

Scarfish
Scarfish
13 years ago

Er…you realize that if you use the card to pay off the interest-bearing debts, you HAVEN’T actually paid them off, right? You’re just moving debt around. I agree with Mike–I wouldn’t take it. Get a second job or cut your spending hard to get a $1000 emergency fund while paying the minimums, and then go crazy on the debt, knocking it out smallest to largest. (Check out Dave Ramsey’s snowball method for a more thorough explanation). Only then would I build up a three to six month emergency fund. I would also NOT keep the credit card. Obviously you are… Read more »

J.D.
J.D.
13 years ago

After re-reading the question, and reading the comments, I’ve come down on the opposite side. I don’t think an emergency fund is appropriate in this case. It’s all credit card money, and pulling money from a 0% credit card to place in an emergency fund is silly. Better to use it all to pay off existing balances.

HOWEVER — and this is important — I think that Ben should be working to establish an emergency fund in the meanwhile. A credit card is not an emergency fund.

mapgirl
mapgirl
13 years ago

I used to think having good credit to your name was your emergency fund. These days, I’m not so sure. I’d definitely build back some of the emergency fund and pay down the higher rate card at the same time if possible.

After the intro offer ends, I’d stop putting money into the emergency fund and pay down all the debt. Of course, I’m not taking my own advice here. It’s very hard to put it all into practice. But aggressive debt payoff really is best.

mapgirl
mapgirl
13 years ago

JD- hm.. If you can make interest on your emergency fund and borrow the money for 0%, why is that silly?

Of course, when the intro rate ends, he’d better have a way to pay off the money he put into the emergency fund… Which in that case, I do see your point.

Stephanie
Stephanie
13 years ago

funny I was just thinking about an emergency fund for us today. For years we have not had one b/c on paper it makes more sense to pay down debt than to save b/c of interest. It isn’t working b/c as many commenters mentioned our credit cards became our emergency fund. We pay down and pay down and wham have to put a big charge on. I wouldn’t use borrowed money for the fund though. For the last few months we have had $25 automatically taken out of our checking. It isn’t much but our budget is tight.When it is… Read more »

Drak
Drak
13 years ago

Here’s my $0.02 — * Use the 0% money to pay off as much of your interest-bearing CC debt as you can. Hopefully that helps to reduce your monthly payments * Pay yourself first – skim 5-15% off the top of your check, and auto-transfer it away to an e-fund savings account. The psychology of this is amazing – if you never “see” it, your mind doesn’t think about spending it. * Whatever is left on your check, use to pay your fixed expenses (rent/mortgage, utilities, etc), and then pay off your remaining credit cards, starting with the highest-rates first,… Read more »

moneymonk
moneymonk
13 years ago

Do both ! give a portion to your debt snowball and a little to your efund.

Lazy Man and Money
Lazy Man and Money
13 years ago

Take the best and worst case scenario of each situation… 1) If you pay off the credit cards and have an emergency, you can always add back to the credit cards – a situation that puts you no worse off than you are. 2) If you pay off the credit cards and don’t have an emergency, you make out way ahead – you’ll have a year of no credit card interest and that might get you completely out of it. 3) If you save it all for an emergency and don’t have one, then you are wasting money by having… Read more »

beanspants1
beanspants1
13 years ago

a normal credit card is not an emergency fund – a 0% one is. i too would not create an emergency fund with borrowed money. i do think it’s safe to take a part of the 0% credit card (less than half)(a balance transfer is way safer than a cash advance) to pay down debts because 0% vs 13-20% is a no brainer. but no way should you create an emergency fund with borrowed money. the long term rates are not in your favor. if you really feel the need for the emergency fund, then take $50-100 from you paycheck… Read more »

Gaming Your Credit
Gaming Your Credit
13 years ago

In my earlier post, I left out the $10k loan in my second calculation. The total was right, but the $10k was missing. It was also off by a dollar because I was rounding on paper while all the actual values stayed in my calculator. Should be

Net worth = $8167-$15764-$10000=-$17597.

Jennifer
Jennifer
13 years ago

I would also stick $1000 into an emergency fund and use the rest to go towards the other cc debt. Then I would work my tail off, including getting a second job doing something, anything, to get it all paid off this year. 1 year at 0% interest will get you very far in paying it off. If an emergency comes up you have 2 choices. Use your EF or use the extra $ in your debt snowball to cover the emergency. If you use the EF though make sure that you replenish it to $1000 before continuing on with… Read more »

Jeffery Hope
Jeffery Hope
13 years ago

Surely its true. Today, there are a whole lot of problems associated with bankruptcy, credit or debt settlements. We can only achieve a better credit-rating or gain a better score by becoming more acquainted about the entire credit system.

Similarly, it has become necessary to understand the overall distribution of the credit score. The following articles: http://www.myfico.com/Downloads/Brochures.aspx would certainly assist anyone who is interested to move up the credit rankings. You may cover this as a new post altogether. And keep up the good work!

Laura
Laura
13 years ago

Dear Ben: I am curious about how much the interest will be in case you are not able to pay off your 0% loan in 12 months. If the interest is significant, and you aren’t completely sure you will be able to pay it all off in 12 months, don’t do it. I would also make the case that hindsight is 20/20. Since you already recognize that not having an emergency fund got you into this mess, you know having one will prevent future messes. I recommend getting $1,000 built up as an emergency fund and cutting up all your… Read more »

Ben
Ben
13 years ago

Thanks to all for your insights! Based on what I’m reading here, it looks like the consensus is for me to take the 0% loan and put it toward credit card debt (or, more accurately, shift the debt around). I’ll be slowly building the emergency fund using money that I earn, not borrow. I think Lazy Man and Money (#21) said it best: “If you save it all for an emergency and don’t have one, then you are wasting money by having to pay the high interest from the credit card company.” One thing I didn’t mention in my original… Read more »

Joseph
Joseph
13 years ago

I’m in a similar situation. But have a few small questions:

1) If moving debt to a 0% card, is it better to apply for the card with all the balance transfers on the application?

2) What about minimum payments? Isn’t it likely you’ll be paying more per month on the new card?

Randall
Randall
13 years ago

It may make things simpler to think of it this way: You say that the new card will be 8% after the 12 months, so we’ll just work with that number for now. Since 8% < 15%, it would be a no brainer to transfer all the debt from the higher card, to the lower card (and probably shuck the higher one in the shredder and get that thing canceled once its paid off… (if you have too many revolving credit lines it impacts your credit rating negativly, so don’t keep it around, because you’re not going to want to… Read more »

Zannie
Zannie
12 years ago

I realize this is a very old discussion, but for anyone else in a similar situation, please consider debt consolidation instead of passing debt around from one credit card to another. To get these no-interest deals you have to open new accounts, which is bad for your credit and creates temptation to use your new credit whether you intend to or not. Debt consolidation services can help you negotiate lower interest rates and lower total minimum payments. Of course you should pay as much as you can each month anyway, but having a lower minimum gives you some breathing room… Read more »

Carole Prietto
Carole Prietto
12 years ago

I thought you said you followed the principles of Dave Ramsey. What you’ve done is go into debt in order to fund your emergency fund and pay down your credit cards. You haven’t snowballed anything, just moved your debt around. Bad plan. Don’t take the balance transfer offer – do the Baby Steps instead. #1: Put 1000 CASH in an emergency fund. #2: PAY OFF your debts using the Debt Snowball. #3: Finish building your emergency fund – not with some rip-off balance transfer offer but by SAVING UP YOUR CASH and putting it away. Dave can get a little… Read more »

RLT
RLT
12 years ago

I’m very curious how it all worked out for the original poster…did he find he was able to pay off that cc when the 12 months was up? Did the cc pull a bait and switch? Did he keep from adding additional debt to that new cc? And my biggest question…sometimes getting cash doesn’t count on the 0% for a year thing…only charges and transfers…How’d it go?

db
db
12 years ago

There is no way I’d take a 0% advance against a credit card and put it in savings as an “emergency fund”. Is that what we’re talking about here? What if you have an emergency before you pay off the advance and need to use the emergency fund for the emergency? Then you’re still stuck paying back the cash advance (or worse, possible stuck in a negative situation where you can’t pay off the cash advance). On the other hand, I have used 0% balance transfers to help get seemingly out of control debt under control. It works, but you… Read more »

brooklynchick
brooklynchick
11 years ago

Dave Ramsey says both – and I have to say, I have a LONG way to go with my debt, but having a small ($1,000) emergency fund gives me a feeling of success – I can tackle the rest!

Charlie Boy
Charlie Boy
10 years ago

If you lose your job, how long would you be able to keep your house and put food on the table? Will credit card bills be more important than say, keeping your house? Why not make sure you can survive if you lose your job and takes you up to a year before you find a new job. I know somebody who is experienced and who was laid off 8 months ago and is now on the verge of losing her home. She has unpaid credit card debt, but her main issue now has become her home because she could… Read more »

Frank
Frank
10 years ago

I say build your emergency fund first because as someone else said life happens. You could be cruising along in your car and all of a sudden Bam! your check engine light comes on. You take it to the mechanic and all of a sudden your’e paying $400 plus for a repair that you have to have done just so you can get to work. Trust me it happens, usually at the worst possible time. Start with a $1000 if you can, or when your income tax check comes in use that to get started. Figure out the percentage you… Read more »

Charlie Boy
Charlie Boy
10 years ago

Building a VERY DECENT emergency fund should be a religion.

Charlie Boy
Charlie Boy
10 years ago

I learned yesterday that emergency fund should be a RELIGION to everybody. This guy who worked here, an executive, well liked, experienced, made a huge contribution to the organization, was laid off yesterday. He had a big salary, had a new hummer and a new Lexus. He thought for sure he would retire here someday, he told me. Well, as it turns out, he was wrong.

There is no safe job. Live each month as though it is your last month in your job.

Janice
Janice
10 years ago

while i see this is an old post people are still commenting, so i’ll add my 2 cents. Let me understand this. You took on MORE debt (albeit 0% for 12 months) so you can pay DOWN (not OFF) your c/c’s (you said using snowball method, that infers to me that you’re not just paying them off) and people think this is a good idea? No matter how you look at it, unless you took that money you borrowed at 0% and immediately paid off all your other c/c’s in total, and now are faced with only paying off the… Read more »

MikeTheRed
MikeTheRed
9 years ago

When I was fighting off my debt about 2 years ago, I went with a hybrid approach between the e-fund and the debt payments. Essentially, I did an 80/20 split. The result was, once I finished my debt off, I already had a healthy emergency fund growing and ready in case anything bad happened.

The peace of mind it offered was essential to paying off my debt quickly and aggressively.

Trevor
Trevor
9 years ago

I think some of the confusion here is over the terms used. I think of emergency funds as being immdiately available reserves capable of covering costs of a appliance/car break down. At most a few £1000. I’d considered money used to cover a period of unemployment as something very different in that you would need to cover a larger amount spread over a longer term. Personally I consider that to be part of general savings, although it maybe put aside in a different savings account so it doesn’t get spent on anything. I would absolutely have an emergency fund put… Read more »

kaitlyn
kaitlyn
9 years ago

Since we’ve decided to save for a wedding, I’ve cut my debt snowball down to a measly extra $50/mo. I tend more towards paying debts with a minimum savings. I think the most my savings ever got to was $3k before I took $2k of it for my debt repayment. It’s definitely hard for me, because I look at the money in savings and think that if I just threw it at my student loans, I’d save $XXX in interest.

Sam
Sam
9 years ago

Hybrid, I have found paying down debt easier than savings. Watching the balances drop on our debt is much more exciting. We established a small emergency fund, which we did tap twice during our 12 and half month debt killing project (once for an A/C repair and once for a car repair).

I’d like to hear more about why the author of the book suggests 3-6 mo. emergency fund before addressing unsecured debt?

EJ
EJ
9 years ago

I think the emergency fund takes precedence. The emergency fund gives you a piece of mind knowing that you remain afloat during big crises (job loss, illness, disability) and take care of issues quickly during small crises (auto issues, appliance replacement). Without the e-fund, all situation become a crisis. Ideally, a minimal e-fund (3 months) should be built up before attacking debt, and once that 3 months is established, a split between the e-fund and the debt snowball (I’d say 50/50 until a full e-fund is established) helps to accomplish both goals while minimizing risk.

Tim
Tim
9 years ago

My wife and I approached it by taking our income, reducing it by tithing, expenses, bills, and a monthly spending allowance. The excess we split equally into three categories. 1) Debt Payoff 2) Emergency Fund 3) Retirement / Home downpayment – 2/3 into a retirement account – 1/3 into a savings account for a downpayment The debt payoff will snowball until all of our debt is paid off in about three years (>$100k) and the emergency fund will be about 8 months of my wife’s pay for now (I am military). The retirement is split as we consider our home… Read more »

retirebyforty
retirebyforty
9 years ago

We don’t have any consumer debt so it’s easier for us to send money to the emergency fund. 🙂

KS
KS
9 years ago

Ã…fter we blew through our $1000 fund three times in one summer (home repair issue, emergency surgery for one of us, and a medical problem for the other), we decided we wanted a different approach. We added to the emergency fund while paying off debts aggressively, then once we got to just the student loans and mortgage, continue to pay a little extra on those while increasing our emergency fund more aggressively. For now, this approach works for us and am glad we took this approach. I will be out of a job in 6 months and while there are… Read more »

Sara
Sara
9 years ago

I do think psychological motivations are important. And some things work better for some people. For me, it made a big difference what kind of debt it was. A credit card might be charging 16%, or even up to 26%. Those just have to go, so it makes sense to keep only a very small emergency fund and put everything to those. However, a car loan or a student loan at 5% is a different animal. If your only recourse in emerrgency is a credit card with a crazy interest rate, then it makes sense to let the low interest… Read more »

Fish Finder
Fish Finder
9 years ago

Having an emergency fund, I believe is essential. During a six month period this year I had to replace my central heat and A/C that died three days before snowing, my riding lawn mower and an emergency, weekend (double rate) septic tank pump due to heavy rains. Total cost $10,725. Having the cash on hand was both peace of mind and no intrest paid on a credit card. Life happens fast sometimes.

Kevin L.
Kevin L.
9 years ago

It really depends on how much financial wiggle room you have. If you’re living paycheck to paycheck, I say first pay off 1 debt aggressively and once that is done, use that extra money to save a small emergency fund. Once that is done, continue to do a hybrid of both.

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