Should I Pay Off Debt or Build an Emergency Fund First?

When it comes to managing your finances, the question of “Should I pay off debt or build an emergency fund first?” is one that many of us face. It’s a tricky balancing act—on one hand, paying off debt gives you peace of mind, and on the other hand, having an emergency fund ensures you’re prepared for the unexpected twists and turns of life.

The truth is, there isn’t a one-size-fits-all answer—but there is a way to navigate it with confidence. However, at LIFE Financial Planners, we’re here to help you navigate these important decisions. Let’s break down the benefits and ‘disadvantages’ of each option so you can feel confident in your next step.

Why an Emergency Fund is So Important

Think of your emergency fund as a financial safety net. It’s designed to give you the flexibility to handle unexpected expenses—without the need to rely on credit cards or loans. We all know life can throw curveballs, and having this cushion means you won’t have to add more stress by going into debt during a challenging time.

If you don’t have an emergency fund, consider setting a goal of saving between three to six months of living expenses. It might sound daunting, but don’t worry—this doesn’t need to happen overnight. By taking small, consistent steps, you’ll gradually build up your savings, and that peace of mind will grow right along with it.

Why Paying Off Debt Matters

While building an emergency fund is essential, if you’re carrying high-interest debt (think: credit cards or payday loans), paying it down quickly should be a priority. The interest on these debts can accumulate faster than you can save, and that’s money you could otherwise use to achieve your other financial goals.

It is often recommended to tackle high-interest debt first, especially if the rates are significantly higher than what you’d earn on your savings. By eliminating that debt, you’ll free up money that would otherwise go toward interest payments—money that can be better invested in your future.

A Balanced Approach: How to Manage Both

Now that we know why both debt repayment and emergency savings are important, how do we balance them? There’s no one right answer for everyone, but here are a few strategies to help you find the right path for your financial situation:

1. Start with a Small Emergency Fund First
   • If you don’t have an emergency fund, we recommend aiming to save at least $1,000 as quickly as possible. This gives you a cushion for minor emergencies, while you continue to focus on paying off debt. Once you have this basic fund in place, you can shift your focus more toward clearing your debts.
2. Prioritise High-Interest Debt
   • If your debt is accumulating quickly due to high interest rates, it might make sense to focus on paying that off first. By reducing your debt, you’ll save money in the long term, and then you can shift your focus to building up your emergency savings once you’ve tackled the high-interest debt.
3. Try a 50/50 Split
   • If you’re in a stable financial position, consider splitting your extra funds equally between saving for emergencies and paying off debt. For example, put 50% toward your emergency savings and 50% toward paying down high-interest debt. This method can help you feel like you’re making progress on both fronts.
4. Adjust as Needed
   • Life changes, and so will your financial situation. We recommend reviewing your progress regularly. If you’ve made significant progress on your debt, you can redirect more of your funds into building your emergency savings. Or, if you’ve built up your emergency fund, you can shift gears to focus more on debt repayment.

Taking Charge of Your Financial Future

At LIFE Financial Planners, we understand how challenging it can be to decide where to focus your financial efforts. But we also know that taking control of your finances today will set you up for success tomorrow. If you need help creating a personalised plan we’re here to guide you every step of the way.

Remember: You don’t have to do it alone. Let’s discuss how we can help you navigate the decision of whether to pay off debt or build an emergency fund. Together, we’ll create a plan that works for your unique situation, empowering you to make confident financial decisions.