How to build an emergency fund when you have debt

  • July 9, 2020

When credit card and student loan payments eat up most of your income, saving money for the future can be hard.

And, if a financial curveball comes your way, setting aside money for a rainy day becomes nearly impossible. All it takes is one unexpected expense to shatter an already strained budget.

Without a financial cushion, you’ll likely turn to credit cards, keeping you in an ongoing debt cycle. But, you can protect yourself with a simple plan that prioritizes where the money goes each month.

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. Depending on your geographic location and other factors, it may take six months or longer to find your next job.

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 emergency fund.

You can pay off debt and save more money faster by earning extra income.

Also, begin 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.

Step 5: Continue your savings habit for financial success

Without debt and with an emergency fund, you’ll be ready to set your next financial goal. It might be saving for your first home or another big expense. Once you get into the habit of saving a little, it becomes easier to save a lot.

Live Well, Bank Well