Saving vs. Paying Off Debts: Which is the Right Choice for this Economy?

I received a great question earlier today from a reporter: Is it better to pay off credit card debt or build an emergency savings account in this tough economy?

This is a tough decision. In the past, the advice has always been to focus on paying the debt off first instead of saving. With a credit card charging 15% APR on your balance and a savings account only earning you 1%, the math isn't too hard to figure out. Your money goes further when you pay it toward your debt repayment.

But this tough economy makes the standard answer not exactly right. The possibility of losing your job is much more of a reality now than it was a year ago. With unemployment at over 8% and rising, you might not be able to find a new job quickly. Emergency funds are needed more than ever.

So, what's the right answer? At some level, it depends on your own money situation. If you already have some emergency savings and could easily find another job, you might want to focus more money on the debt repayment. If you have absolutely no savings and few options in the event that you lost a job,  maybe paying the minimums on your credit cards and building up your savings is the better choice.

Here are a few things to keep in mind when building an emergency savings account:

• Aim to have enough in your savings account to cover six months of necessary expenses. This includes mortgage or rent, credit card and loan minimums, insurance payments, and utilities.
• Be sure to count your unemployment insurance benefits when you're calculation how much you'll need each month.
• Don't forget to also include COBRA or other health insurance coverage in your plans. 
• Keep your funds in a high-yield savings account for the best savings rate and easy accessibility.
• Don't be afraid to start small. If six months isn't possible with your finances, start with a goal of saving enough for one month. 
• You should also have some extra available credit through your credit cards in case of an emergency. Only use a credit card for your expenses if you've run out of other options and have a good plan for repaying the debt. 

What would you chose: debt repayment or savings? Share your opinion in the comments section below.

Emily Peters – Credit.com's personal finance expert and former TransUnion credit bureau insider. Emily writes about credit reports, credit cards, loans and personal finance as the CreditBloggers.com editor.

Comments

[zach Vitale]

i've got 5100 dollars in debt and 3500 in an emergency fund. i'm also about to get 1500 in a tax refund... i think i'm going to put my tax refund towards my credit cards, though. i'd really like to get those paid off. it will be a great feeling to pay them off, and once that's paid off, i can put all of those resources towards my emergency fund immediately.

[elementaryfinance]

I think in this environment, you should pay off your debts. Worse comes to worse, you can recharge up your cards but getting unlevered is so important right now.