We're told we're supposed to save for emergencies so that we're not forced to resort to debt when unplanned expenses come our way. Yet 29% of Americans currently have a higher level of outstanding credit-card debt than they do emergency cash, according to a new Bankrate report. On the flip side, only 44% of U.S. households have a higher level of emergency savings than what they owe in credit-card debt. And that means a large number of Americans had better start working on cleaning up their finances -- immediately.
The relationship between emergency savings and debt
A lack of emergency savings is a huge driver of debt, and for one simple reason: Most Americans max out their paychecks on a regular basis, and so when they're forced to tackle an unanticipated expense, their only choice is to tap their savings or charge that bill on a credit card. If you don't have savings to access, you'll be stuck with the latter option.
Of course, that's a problem for several reasons. First, whenever you carry a credit card balance, you automatically end up paying more for a given expense in the form of accrued interest. Not only that, but having too high a credit card balance can hurt your credit score. That's because credit utilization is a big factor that goes into determining that number, and if you find yourself carrying a balance that exceeds 30% of your total available credit, your score can take a tumble. Once that happens, it can become even more costly to borrow money again. Talk about an unhealthy cycle.
Getting your priorities straight
If you're in a situation in which your outstanding credit card debt exceeds what you have in your emergency fund, you might assume that your first focus should be on paying down your balance. In reality, however, you're better off building some cash reserves and then eliminating that debt.
Here's why: The longer you go without emergency savings, the greater your risk of racking up even more debt to add to your existing load. Furthermore, if you max out your credit limit and encounter a need for money, you might not even have the option to borrow what you need. On the other hand, if you have some money in the bank, you'll be better equipped to handle a new emergency so that you don't dig yourself further into a hole.
How much money should your emergency fund contain? Ideally, enough cash to cover three to six months' worth of living expenses. The logic is that the sum you sock away should be able to not only pay for a major expense, like a home repair or medical bill, but also get you through a period of unemployment in the event that you lose your job.
If you're starting with nothing in the bank, you're not going to accumulate several months' worth of living costs overnight. But what you can do is start immediately cutting back on expenses to save small amounts of cash here and there. Adding even $30 a week to savings is better than doing nothing.
On a more long-term basis, you'll need to rethink your lifestyle. That could mean downsizing to a smaller home to save on rent, giving up a car you can live without, or spending less on restaurants and leisure until you're in a healthier place financially. At the same time, you might look into getting a side hustle and using your earnings to boost your savings.
No matter what steps you take to build an emergency fund, make it a priority. Once that's done, maintain the same habits to chip away at your outstanding debt until it's gone. With any luck, having that safety net will prevent you from whipping out a credit card the next time an unexpected bill hits you out of the blue.