Is it Better to Have a Cash Emergency Fund or Pay Down Debt?

Conventional financial wisdom has always held that consumers should both pay down their debt and have an emergency fund to cover unexpected expenses so they don't have to dip into credit again. But under some circumstances, putting money on idle while their creditors are charging interest on every dollar of debt makes little financial sense. One option is to keep your finances fluid so if you need emergency funds you know where you can get them.

Reasons for Cash Emergency Funds

The idea behind the cash emergency fund is that, if your car broke down or you had an emergency medical situation or some other big expense, you would have a money to cover it without dipping into savings or using credit. Budgeting for emergencies keeps your finances in control and avoids derailing other financial plans. Many financial advisers suggest consumers should set aside enough money to cover one to six months' worth of expenses.

Reasons Against Cash Emergency Funds

One problem with cash emergency funds is that, when people are barely making it from check to check or paying off debt, it seems wasteful to leave large amounts of cash lying around. Another problem is that, in the economic slump that began in 2009, many people have been unemployed for years. An emergency fund set aside to pay the bills for a few months would have been depleted long before the emergency subsided.

Why Paying Debt is Better

Generally speaking, more money will be lost in paying interest on credit over a long period than will be earned by an emergency fund in an interest-bearing account. Accounts where cash is readily available often have low interest rates, according to MSN Money, so consumers end up losing money in the long run if they divert money from paying off debt to building an emergency fund.

Achieving Liquid Funds

The solution, according to Liz Pulliam of MSN Money, is to forego an emergency fund if your current financial situation makes it an untenable solution and instead create some liquidity in your finances. Make sure that if you need to get hold of some money quickly, you have a place to go. Keep credit clean so that if you need an emergency loan you can qualify for a favorable one, such as a home equity line of credit. These loans generally have low interest rates and are not considered risky credit as much as credit cards.