The CARES Act (Coronavirus Aid, Relief, and Economic Security Act) that was enacted in March calls for direct stimulus payments to most Americans. If you qualify for a stimulus check, you may receive as much as $1,200 and an additional $500 for each qualified dependent.
More Resources: Calculate Your Stimulus Payment
Many Americans are curious how to best use these funds. Because we have over 45 years of experience helping people resolve their debts, people are wondering from us if they should use their stimulus checks to pay down debt. Here are the best ways to use your stimulus check:
Create an emergency savings fund
Before considering using stimulus funds for debt repayment, first make sure you establish an emergency savings fund. If there was ever a time that proved the need for an emergency fund, the coronavirus pandemic is it.
We’ve long advised that an emergency fund should be every consumer’s first savings priority when budgeting. The goal is to accumulate enough money to get through a period of lost income or pay for an emergency purchase that needs to be made, but avoid going into debt to do it.
Learn More: How to Start an Emergency Fund to Prevent Debt
What’s an emergency?
- Lost income—if you lose your job, or are temporarily furloughed (as many have been due to the COVID-19 pandemic), you will need to be able to get by and do your essential spending without having to go into debt.
More Resources: Find Your State’s Unemployment Office Website The CARES Act expands unemployment insurance benefits to three groups that don’t normally qualify for financial relief: gig workers, independent contractors, and the self-employed.
- Emergency expenses–if something comes up that you simply must pay for, like a broken water heater or car repairs needed to get to work, then the emergency fund can be used without putting you deeper into debt.
Grow your emergency savings fund
If you already have an emergency fund in place, then your second priority for using your stimulus check is to increase your existing emergency fund.
To understand this, remember the top priority for emergency savings is to replace lost income. We generally advise people set aside three to nine months’ income in an emergency fund to get through a period of unemployment.
Statistically, the average person who becomes unemployed takes 22 weeks to get back to work, or 5 ½ months. That’s squarely within our three to nine-month income goal. But due to the coronavirus, expect unemployment to be a bigger problem (and last longer) than usual.
That means if you can’t live for a full nine months on the amount you have in your emergency savings fund, add your stimulus check to that account to work toward that goal.
How much do I need for an emergency fund?
- While we’re saying nine months’ income, we mean the amount of income you need to survive for that long. Maybe you would normally have $28,000 in take-home pay over those 9 months, but if you tightened your budget and cut all unnecessary spending, you could survive on half that amount. That means you would want $14,000 in your emergency savings fund.
- You don’t have to stop at nine months. Some advisors say we should all have 12 months’ income in an emergency fund. When you think about the kinds of emergencies people face—like unexpected medical emergencies—the amount of money needed can be astronomical. It’s easy to imagine scenarios that could deplete even a large emergency fund rather quickly.
- Even if you can’t build up a large fund, save something—it’s critical to have a fund in place, even if it’s not big enough. So even if your stimulus check won’t get you to your savings goal, you should still add that money to the fund and keep saving.
Should I invest my stimulus check?
Some financial advisors tell people to try to use stimulus funds to make more money by investing it. This isn’t necessarily a great idea—these funds are being given out to help everyone get through a crisis together, and it’s important to handle this money with care.
That doesn’t mean it shouldn’t be stored in a way that earns some interest, but any investment with a good return will carry some risk, and risk is not what you want for your emergency savings fund.
Where should my emergency fund be kept?
- A savings account at your financial institution is a safe, accessible way to store those funds. It won’t earn much interest, and when you consider inflation, it will most likely lose value while it sits in your bank or credit union. But you won’t have to pay penalty fees if you access the funds during an emergency.
- A money market account might be a better option if you have access to one through your financial institution. But this account will have a minimum balance that you should plan to stay above, so it will only be an option if you’ve made good progress toward building your emergency fund.
- CDs, or certificates of deposit, can offer better interest rates, but aren’t typically a good option for an emergency fund, because you have to pay a penalty to withdraw the funds early. One way to take advantage of this vehicle is to put 6 months’ income in an accessible account, and any amount over that in a 6-month CD that you can cash out safely after six months if you still need to make use of your emergency funds.
- Roth IRAs are funded after you pay taxes on your income, and you could withdraw your contributions from them safely without penalties or extra taxes. That makes them an acceptable option for emergency savings, but if you withdraw the earnings from your Roth IRA early, you will pay penalties. The down side here is that you can’t return those contributions to the IRA after you’ve withdrawn, so you’ll lose out on the potential growth toward your retirement.
It’s critical to not mix up a Roth IRA you set up for emergency savings and one you set up to fund your retirement. Really, Roth IRAs shouldn’t be your first choice for an emergency fund, unless you think it’s very unlikely you’ll need to access the full emergency fund during your working years.
When to use your stimulus funds for debt
Unless you have nine months’ or a year’s income in your emergency fund, you shouldn’t use your stimulus check to “pay off” debts. That doesn’t mean you shouldn’t use stimulus funds to keep making your regular monthly debt payments, though.
Part of the essential expenses you’re trying to protect with an emergency fund are your debt payments. If you can’t make your credit card payments, you’ll risk incurring fees and possibly trigger high penalty rates.
Learn More: What if I Can’t Pay My Mortgage?
If you’re going through a financial crisis and your income has been interrupted, then using some of your emergency funds to make the minimum payments toward your debts is warranted—it’s going to keep your car from being repossessed, your home from being foreclosed upon, and your credit cards from going into default.
It might be tempting to pay off a smaller credit card debt—say you owe $1,200 toward a credit card and you’ve just gotten your full stimulus deposit. If you make only the minimum payments for 6-7 years, you’ll increase the total debt by more than 50%, to over $1,800. Surely it makes more sense to pay off the $1,200 now and eliminate that debt altogether.
Under normal circumstances, maybe. But during this pandemic, if you’re in danger of losing your income, the emergency fund is more important. Pay what you have to in order to avoid late fees or penalties, but put everything extra into emergency savings.
If you can’t make your minimum credit card or automobile payments, be sure and call your lender’s customer service department, or check their websites and apps for information on their hardship programs that may permit you to skip a payment, and not impact your credit rating. If you normally pay bills by autopay, review those. Change them as needed so you don’t overpay accounts or cause an overdraft.
If you’ve lived without an emergency fund and it’s gotten you into debt trouble, get help from a trusted nonprofit source. Talk to a certified debt coach and get help creating a budget that will help you pay down debt, grow emergency savings, and prepare for the unexpected.