There's an on-going debate around what you should do if you're in debt: pay off your debt first or establish an emergency fund, then pay off the debt. My basic philosophy was detailed in Comments: Over One-Quarter of the Population on the Brink of Financial Disaster, Need Discipline where I stated:
I recommend paying off the debt first because: 1. it's costing you money (a lot) that's digging you deeper into debt and 2. if you pay it off, it's not like that money's gone. You can charge again if you HAVE to (if you get into trouble financially) This has the same effect as saving money for future expenses. However, if you save first, you're paying interest on the debt the entire time you're saving. Doesn't seem like a smart move to me.
To add a few more specifics to this, here's what I'd recommend as the order:
3. Pay off other debt.
To add to the debate, here's a piece from USA Today that throws another element into the mix -- saving (in particular, for retirement). They give some thoughts on paying off debt versus establishing an emergency fund versus saving for retirement. But first, they tackle the debt versus emergency fund issue. Their thoughts:
The return on paying off debt is roughly equal to the interest rate you pay. Many credit cards charge 18% or more: You'd be hard-pressed to find another investment earning 18%. "It's like giving yourself a risk-free 18% return," says Don Lutomski, a financial planner in Birmingham, Ala.
Consider a couple with $10,000 in credit card debt. They paid 18% interest. The credit card company requires them to pay at least 4% of their balance each month, or $35, whichever is larger. If they paid just the minimum, they'd be paying for more than 10 years. Total interest: $5,575.
But if they paid $100 more than the minimum each month, the couple would end up repaying the entire balance in 50 months, a bit more than four years, saving $2,285 in interest. Best of all, they would have wiped out their debt, boosting their cash flow by $265 a month.
By contrast, the returns from a savings account seem paltry. Had you stashed your $100 a month into a bank savings account paying 5% for 50 months, you'd have about $5,424 in your account at the end of the period. You would have earned just $425 in interest.
This is the same rationale that I use when recommending that people pay off credit cards first. Financially, it's just the better option of the two.
But USA Today isn't making this a firm recommendation. They hedge their bets a bit here, noting later in the article that emergency savings are important too (which I agree with), especially when you lose your job. As such, here's their recommendation:
Your best strategy: Build up your savings at the same time that you pay down debt.
Now that's useful advice, huh? Why not just state the obvious?
It doesn't seem very practical to me to do both -- besides, it really results in no recommendation at all. I'd love to say "do it all" in all of my recommendations, but that's not very helpful in my opinion.
The rest of the article hems and haws and really doesn't make a complete recommendation, so I'll make one:
3. Pay off your credit card debt.