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If you are currently working your way through paying off debt or are considering starting, it is possible you are missing an important step — having an emergency fund.
It’s tempting to want to move full-speed ahead and start attacking your debt with a ruthless vengeance. And you should — when you get to that point. But just like getting organized is a necessary precursor to paying down debt, so is having an emergency fund.
Establishing an emergency fund is vital to any stable financial plan. You need to be protected in the event of a job loss or any unforeseen event that will impact you financially. Anywhere from three months to a full year’s income is recommended.
But what if you’re still in debt? Do you focus on the emergency fund or the debt? And how can you possibly save that much money when you’re struggling with debt? This is where the “beginner emergency fund” comes into play.
Also known as Baby Step 1 as outlined in Dave Ramsey’s Baby Steps, the beginner emergency fund is meant to provide a basic level of protection while you are paying off debt.
So why is having an emergency fund a priority if you’re paying off debt? You just want to make as many payments as possible on your credit card and stop paying those ridiculous interest rates! Setting aside money and earning little to no money on it seems like a waste. Here’s why it is so important.
You’re Going to Have an Emergency
It may not be pleasant to think about, but the truth of the matter is, you’re going to have an emergency. You don’t know when and you don’t know what it is, but an emergency of some kind is coming your way.
It could be car repair; it could be a broken washing machine. Whatever it is, you want to be prepared. When you have some money set aside and an emergency rears its ugly head, you handle the emergency, and you move on.
Without an emergency fund, be prepared for a lot more stress, because not only are you dealing with whatever the emergency is, but now you’re also trying to figure out how you’re going to pay for it.
You’ll Avoid Going Further in Debt
Having an emergency fund in place will prevent you from going deeper in debt. Let’s say instead of establishing an emergency fund, you proceed with paying off your debt. You knock a couple thousand of dollars off one of your credit cards. Great, way to go!
Then your car breaks down — the repair bill is $800 You don’t have $800. How are you going to pay for it? Oh, right — the credit card! You put the repair on the credit card because you have no other way to pay for it. Your car is fixed, but now you feel a little defeated because some of your hard work is undone.
Establishing an emergency fund challenges the conventional wisdom of having a credit card to handle emergencies, but remember you’re paying OFF your debt. If your only way to handle a potential emergency is to go further into debt, then you’re just digging a deeper hole for yourself.
You may be familiar with the startling statistic that 63% of Americans don’t have enough money to cover a $1000 emergency. Ask yourself — if you had an emergency to the tune of $1000, would you rather handle it with cash or with a loan from Visa?
While you are paying off your debt, your beginner emergency fund should be big enough to handle minor things that may come up, but not so big that it takes you a long time to build it up.
How Much Should You Save?
Depending on your income situation, expenses, family size, and what number will allow you to sleep at night, anywhere from $500-$2500 could be a good amount for a beginner emergency fund. $1000 is recommended in Dave Ramsey’s Baby Step 1. However, I recommend leaning towards $2500 if you have a big family, multiple cars, or you just feel a little more secure with a slightly larger emergency fund.
You want enough to handle car repair or a misbehaving appliance, but not so much that your focus shifts from dumping your debt to building up your fund.
How To Save Up An Emergency Fund
The goal in saving your emergency fund is to do it as quickly as possible. You want to protect yourself as soon as you can, and you also want to get back to the business of dumping your debt.
Consider reducing some of your monthly expenses or try a money fast to reach your goal. Bring in money by selling unneeded items, working overtime, or taking on a temporary side job.
Use any expected future funds like a tax refund, bonus, or monetary gifts. If you already have some money that you just see as “savings,” designate a certain amount of it to be your emergency fund.
Again, the goal is to do this quickly.
Related Reading: How to Save $1000 Quickly, How to Squeeze $500 Out of Your Budget
Okay, so we’ve covered why having an emergency fund is important and touched on how to save it. Now, where do you keep your emergency fund? In a place where you won’t touch it!
If you are disciplined and know you won’t touch the money unless you are experiencing an actual emergency, then having your emergency fund in your savings account will probably work for you.
However, if you are in the beginning stages of your debt-free journey and you struggle with discipline, your emergency fund needs to be in a place where you won’t be tempted to spend it. This is not your checking account or in a savings account from which you can access the money within seconds.
Having the money too accessible will provide you opportunities to chip away at the emergency fund you worked hard to build. $10 here, $50 there, and before you know it — it’s gone! You need to protect yourself from yourself by making it accessible but not too accessible.
Money Order
This is a bit unconventional, but consider purchasing a postal money order or orders for your beginner emergency fund. I recommend this to friends and clients if they are likely to go out to dinner with their emergency fund. I personally used this tactic because I had zero discipline when I began paying off my debt.
Yes, this will cost you a couple of dollars, but your emergency fund will remain intact — at least until you need to use it for a valid reason. If you do need to access it, you can do so with a trip to the post office. The slight inconvenience will keep you from blowing your emergency fund.
Online Savings Account
Another great place for your emergency fund is in an online high-yield savings account where you will earn a higher interest rate than at a brick-and-mortar bank. We’re still talking 1% or less, so a higher interest rate isn’t the real motive here.
By saving at an online bank, you also are keeping your fund accessible but not too accessible. The account is linked to your existing checking or savings account, but there is usually a waiting period of a day or two when transferring between accounts. Again, the slight inconvenience reduces the chance of you using your money irrationally.
Capital One 360 Savings is a good option. You can get an immediate $25 bonus with an initial deposit of $250 with this link. Ally Bank and American Express also offer high-yield savings accounts. If you are uncomfortable with having to wait one or two days to access your money, consider keeping a small amount accessible in your existing savings account and the rest in an online savings account.
Having a beginner emergency fund should give you some peace of mind. Even though it isn’t tens of thousands of dollars, you’ll enjoy the security of knowing you can handle most “oopsies” without compromising your financial situation. Hopefully, you won’t have the “opportunity” to use it, but be prepared to use it when needed.
Consult Your Budget First
When a valid emergency comes up, before automatically going to your fund, try to cover the expense entirely or partially with money you already have. See if you can budgetin the emergency by reducing or delaying other spending. This should always be the first defense. If you are unable to cover the expense, then it’s time to access your emergency fund.
Use It!
Now that you have the fund, be willing to part with it if an emergency comes up. It is not unusual for people to want to hoard their emergency fund a little. They just see it as savings and sometimes are more willing to cover the expense with a credit card than to part with the cash.
Again, you’re trying to get OUT of debt. Instead of thinking of this money as savings, remember it is specifically for emergencies. Use the emergency fund when you need to.
If you do dip into your fund, then take some time to build it back up to the original amount once you’re done handling the emergency. Yes, this means slowing down on paying off the debt for a little while, but for all the reasons of establishing the fund in the first place, you want to replenish it.
Urgent ≠Emergency
Beware of convincing yourself that something is an emergency when it isn’t. Urgent does not equal emergency. House repairs that are improvements or upgrading your dishwasher aren’t emergencies. Those are expenses that can be planned and saved for.
Your fund should only be used to cover valid emergencies. Consider writing a list of events that qualify as emergencies for your household ahead of time. That way you have established guidelines to help you avoid misuse of your emergency fund. You can refer to the list and make a calm, well-thought-out decision on whether or not to use the fund.
I vividly remember dealing with replacing a furnace in my house while I was deeply in debt. We didn’t have the money or even enough room on a single credit card to pay for it. We had to split the cost between a check ANDtwo different credit cards —yikes! Since establishing an emergency fund, handling life’s bumps has been so much easier.
Of course, it’s not fun parting with money when something unexpected comes up, but you will appreciate being able to focus on the emergency and not its financial impact. You will experience a tremendous amount of peace knowing you are prepared for the unknown.
Do you have an emergency fund? If so, have you had to use it? If you don’t have one, why not?
