Do I prefer an emergency buffer or being debt-free?
18 Jul 2024
5 min
Recent research by the Dutch Central Planning Bureau (July, 2024) shows that Dutch households have started saving more and more over the past twenty years, mainly to pay off their mortgages. This means that, on average, Dutch people have a smaller emergency buffer, because the mortgage is paid off from savings. This raises important questions: what exactly is an emergency buffer, and how big should it be? What is more important, an emergency buffer or paying off debts such as a mortgage? In this blog we discuss what an emergency buffer is, and whether it is more important in your situation to pay off your debts or build an emergency buffer.
What is an emergency buffer and how big should it be?
An emergency buffer is an amount of money that you set aside for unforeseen expenses, such as a broken washing machine, car maintenance or even temporary unemployment. The idea is that you will not get into financial trouble when these unforeseen costs arise.
But how big should such a buffer be? Most financial experts recommend having a buffer of at least three months of average expenses. This gives you enough time to stabilize your finances without having to immediately take on debt or sell any investments. For some, a three-month buffer may be sufficient, especially if you have a stable job and expect few unforeseen costs. For others, especially those with uncertain income or higher fixed costs, a buffer of six months or more may be necessary.
What is more important: An emergency buffer or paying off debts?
This question is often asked to Equip's financial experts. It is therefore not easy to answer this question, as it is different for every personal situation.
Paying off debt, especially with high interest rates, can save you a lot of money in the long run. On the other hand, an emergency buffer provides financial security and can reduce stress by knowing you are prepared for unexpected expenses.
A good approach is to find a balance between the two. Start by building up a small emergency buffer, for example 2 times your monthly expenses. This is enough to cover most minor financial emergencies. Then you can focus on paying off high-interest debt. Once these debts have been paid off, you can continue to replenish your emergency buffer to the desired level.
People like me pay off debt faster, should I do that too?
The CPB research shows that more and more households are paying off their mortgage faster. This is partly due to stricter mortgage rules after the 2008 financial crisis, which made interest-only mortgages less attractive. But does this mean that you should also pay off your mortgage faster?
That depends on your personal situation. Paying off your mortgage faster can save you a lot of interest in the long term and give you financial freedom. On the other hand, if your mortgage has a low interest rate, it may be wiser to invest in other things that offer higher returns.
If younger generations are repaying more than previous generations, this means that mortgage repayments are likely to be a trend that will continue. This can be beneficial to your long-term financial health. Still, it's important to consider your own financial goals and situation before making a decision between paying off debt or building up an emergency buffer.
Conclusion
A good balance between building an emergency buffer and paying off debts is essential. In addition, paying off your mortgage faster can be a wise choice, depending on your personal situation and financial goals. The best thing to do is to talk to a good financial planner, who can help you with these considerations.
With Equip you gain insight into your personal finances, for example how much you really have left over per month - and therefore also how much you could save. With the easy contact with our financial planners, you can also determine how large your emergency buffer should be for your personal situation; 3, 4 or maybe 6 months of your monthly expenses.