Paying off debt and building an emergency fund can feel like competing goals. Can you really do both at once? We have some ideas to make it possible!
It’s true, if credit card and student loan payments eat up most of your income, saving money for the future can be difficult. Add in a financial curveball, and it can shatter an already strained budget. That’s why a financial cushion is so important. Protect yourself with a plan that prioritizes building an emergency fund and then shifts attention back to debt reduction. Here’s a five-step plan to do just that.
Step 1: Focus on building an emergency fund
Saving for the future and making extra debt payments are smart money moves. But attempting both at the same time can be frustrating. That’s because splitting your available funds between each task slows results. Instead, focus on building an emergency fund. Make only the minimum required payments on your debt obligations. This should free up funds in your budget to help you save more in less time.
If you’re concerned this will mean you’re only paying interest on your debt, contact your creditor. Request a temporary interest rate reduction. A lower interest rate allows more of your payment to go toward the principal amount.
Step 2: Establish an emergency fund savings goal
Setting a savings target for your emergency nest egg will help focus your efforts. It might also help you achieve the goal sooner. Financial experts recommend saving three to six months of living expenses. This amount can help cover your bills if a job loss occurs.
If living expenses equal $5,000 a month, a three-month emergency fund will total $15,000. This amount can seem daunting, but you can start with smaller goals and work up to larger ones. Once you hit a target of, say $500, try to do that again. The most important action to take at this point is to select a goal amount and stick to it.
Step 3: Make minimum debt payments while building your emergency fund
On-time payments to your creditors are vital to maintaining good credit health. Continue to pay your bills by the due date. It’s the amount you’re paying that you may want to change. Consider only making the required payment listed on your account statement. Then, calculate your typical debt payment, less the required amount, and funnel the difference into savings.
Step 4: Refocus your efforts on debt reduction
After you’ve met your initial emergency fund savings goal, it’s time to tackle your remaining debt. The sooner you become debt-free, the sooner you can work on building your savings further.
Consider beginning with the highest interest rate debt or those that do not offer tax benefits. For example, it might be a better financial choice to chip away at a credit card balance than a student loan. The Internal Revenue Service allows taxpayers to deduct up to $2,500 of the interest paid on qualified student loans each year.
Look for ways to apply more funds toward debt. Challenge yourself to increase the amount leftover each month for debt reduction. Start small to make it feel manageable. Choose a dollar amount goal, and see what you can do to get there. Let’s say it’s an extra $100 per month. Could you find $50 by cutting expenses and $50 in extra income from a side gig or selling unwanted items?
Step 5: Continue your savings habit for financial success
Stay motivated by thinking about what those extra funds can be used for when debt is paid off. When you have an emergency fund built and have paid off your higher interest debt, now you get to decide what new things those dollars get to do. Will you save for your first home or another big expense? Or plan for a vacation? Keep your future financial goals in mind. And, know that once you get into the habit of saving a little, it becomes easier to save a lot.