Building Reserve Fund First Or Paying Debt First?

Building Reserve Fund First Or Paying Debt First?

Recently there are an interesting article which one of the author recommend to the consumers who have long standing issue with debts on credit cards are being advised for paying the minimum requirement limit to your credit card monthly while building a 8 month emergency fund before paying the rest back to the debt you owned.

While the idea has sparked off many interesting discussion, I too came with my own conclusion as I have a slightly similar experiences. Well, I never had any owe loan to banks but I do have a personal debt. My advises? Pay slightly more to the credit minimum payment and reserve the same amount for your emergency fund if you are able to do that. The first reasons are paying slightly more to the credit you owe your bank helps to slightly decrease the interest rate charge by your bank in an over long term period. This is especially true if your interest rate was charge according to the % of the amount you owe. For example if you owe 3000 and have an interest rate of 5% charge to your account every month (which is about $150). If you only pay the minimum amount $150 each month for a year, you will still owe $3000. Therefore at the end of the 1 year, you need to pay a total of 4,800. On the other hand, if you decide to pay more than the minimum amount for example ($200 a month). By the end of the 1 year, which is 12 months, you will be only paying a total of 4604.174. Comparing between the 2 methods, you will end up saving about $195.826 if you decide to pay more than the minimum.

The second reason is that emergency fund is needed for one reason: EMERGENCY. You can never tell when you suddenly needed some reserve fund. Have you been in the situation where your item broke down on the time where your budget is on tight? If you do, I believe you have already understood the power of keeping some emergency fund. In any case, building emergency fund will help to reduce your stress and give you peace of sleeping even if some unexpected situations arise.

The third reason is that: No one can tell the future. Sure you can build a fund of 8 months first and pay minimum on your credit. But if everything was going smooth, you will end up paying more for your interest charge in long term. On the other hand, if unexpected situation arise and your reserve fund is not fully ready, you may be having trouble time indeed. You definitely do not want to end up using your credit and end up owing more to the bank than you already had.

My advise would be: Pay your debt which is slightly higher than the minimum requirement and save reserved fund which is equal to 3 months of your monthly expenses. This ensures that your interest charge to your debt will be slightly reduced over time and you will save some substantial amount. Once you have a minimum of 3 months reserved fund, you can then allocate equal amount to paying your debt and building emergency fund.