Often people remain in a dilemma whether to clear all their debt or save money for their future or any kind of emergency. Ever since the pandemic situation started worldwide many people are under heavy debt. As per the data available, only 4 out of 10 Americans have got enough savings for an emergency.
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What should you consider while deciding?
According to financial experts, you must look at the rate of interest that will be charged on your debt. Based on that you must move the fund. If your rate of interest on debt happens to be quite low, then you may split your fund 50/50 between your debt payoff and savings for an emergency.
However, if the interest rate is too high, then you must focus more on debt, and 90% of the amount should be utilized for clearing your debt and the rest 10% must go to your emergency savings fund.
Your debt may go very high in the long run if the interest rate is too high and perhaps you may have to borrow again to pay off your debt. Rather you may have a less emergency fund and clearing the debt becomes your priority.
A few other things to consider are as follows:
1. What is your current job situation?
If your job situation is not very good and likely to be fired soon then you must give more attention to your emergency savings, otherwise, you will be forced to use your credit card more and increase your debt further.
If you are likely to get some funds from your employer after you are fired, that money should be used judiciously.
2. How much emergency savings do you have?
A rule of thumb will be if you are earning $30,000 in a year, then you must save up your 3 months' amount of your living expenses. In case, you are earning $60,000, then you must have 6 months' worth.
If the situation is such that you need to draw money from your savings every month then revise your budget.
3. Do you need other savings?
If you have a specific plan, for example, to buy a new car within a few years then you must save some more for that otherwise you will again increase your debt.
4. Are you expecting any money from somewhere?
If you are expecting any money soon from a retirement fund or any such thing then use the following formula:
- 30% for your needs like replacing broken appliances, repairing your car, and preventing any debt
- 25% to pay for your debt
- 20% for your savings
- 15% for your long-term investment
- Only 10% for your fun spending
However, in case you have got no emergency fund, then use the following:
- 35% for your emergency saving
- 30% for your needs
- 25% for clearing your debt
- Only 10% for fun
In certain situations, the basic thumb rule may not work. For any drastic situation, you will need drastic measures.