Should you grow emergency savings or pay off debt first?

A young couple sits at a kitchen table, with bills spread out in front of them. The woman laughs and hides her face, while her male partner laughs, reading a piece of paper.
April 01, 2021 | Claire Hegstrom

When an emergency strikes, you may need to empty your emergency savings fund, and use your credit cards to pay for the bill. When you’re done taking care of the unexpected costs, you’re left with credit card debt, and a depleted savings account.

So how do you tackle getting your finances back on track? Is it smarter to replenish your emergency fund first, and then pay off the debt? Or tackle the high-interest credit card balances prior to anything else?

Before you jump into action, take a minute to feel good about the fact that you had an emergency savings fund to use! While it can feel scary in the moment to empty your account in a dire situation, that is exactly what the money was for. Let’s lay out a plan for what you’ll want to do next.

Start rebuilding your emergency savings account

The single most important financial tool to have in your back pocket is an emergency savings fund. Having even a small nest egg saved can spare you from detrimental impact to your credit score due to collections, or help you avoid the burden of interest charges from credit card debt. Just one quick trip to the hospital could severely ding your credit score if your credit limit isn’t high. Imagine having to run to the ER with your $3,000 limit credit card. The average cost for a non-emergency visit to the ER is $2,000, leaving you with 66% credit utilization once you’ve paid the bill.

America’s most trusted personal finance expert, Suze Orman, suggests having 8-12 months of emergency savings before aggressively paying off debt. Rebuilding a year’s worth of expenses can feel overwhelming at first, but Orman reminds anyone starting from scratch, “Millions of people had to use their emergency funds over the past year, and now is the time to start over again;” you’re not alone.

Transfer your credit card balances to a low-interest credit card

High-interest credit card balances can take a toll on your credit score. It’s harder to pay down quickly, and your credit utilization takes longer to decrease because accruing interest keeps adding to your balance.

Your credit utilization accounts for 30% of your credit score, so if possible, you should try and transfer your balance to a lower-interest or no-interest credit card with a higher credit limit. Balance transfer credit cards often have a 0% APR (annual percentage rate) promo period for a year, so you can focus on replenishing savings, without worrying about racking up more interest each billing cycle.

Resist the urge to drain your retirement plan to pay for high-interest credit cards. Remember, it’s not as much about the amount of money you deposit into your retirement savings every month as it is about when you start to save for retirement. Draining your retirement accounts for the quick payoff of diminishing credit card debt will erase all the compounding interest you’ve worked toward.

After replenishing your emergency savings, start tackling credit card debt

Ideally, as you’ve been setting aside money each month in your emergency savings account, you’ve also been paying the minimum payment on your credit cards. Suze Orman recommends only paying the minimum amount on each card while working your way back from a big expense. But remember, making those payments is important because payment history is the largest factor of your credit score at 35%.

Orman suggests that even if you have other forms of debt—student loans, mortgages, etc.— focus on credit card debt first. While all debt may feel negative, remember some things are considered “good debt” by lenders, like student loans and mortgages. These types of debt are viewed as an investment in your future.

There are multiple methods for paying off credit card balances. Orman recommends an approach that can easily fit into your budget once you can back off on your aggressive emergency savings goals.

To start tackling your debt, first add the minimum payments of all your credit cards together. Then find 20% of that total amount, and pay that extra 20% to your highest-interest credit card. For example, if you owe $200 in minimum payments total, you’d make the minimum payment to your highest-interest credit card, and pay an extra $40 on top of that.

Once you’ve paid off your credit card with the highest interest rate, you can put the extra 20% to your next highest-interest card, and so on until you’ve successfully paid off all balances to zero.

Saving money after an emergency and getting credit card debt under control is a process, and unfortunately can't be done overnight. Trust in the process and know that these things can happen to everyone. Having credit cards and an emergency fund to use in the first place is something you should feel proud of.

To learn more about budgeting after an emergency, check out these blogs:

Claire Hegstrom is an advocate of the credit union movement through and through. Passionate about financial education, she approaches money conversations from a candid and inclusive space focused on growth and awareness. As our credit union founding father, Ed Filene, once said, “Progress is the constant replacing of the best there is with something still better.” Claire hopes reading Money Mentor will help transform your life from the best to even better.

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