Featured Image: Wait You Need This
Article By: Emily Hunter
Are you familiar with the expression “one step forward, two steps back”? If you’ve ever tried to get out of debt, you probably hate this expression. Getting out of debt can feel just like this. But what if I told you there was a way to put a block under your feet as you climb out of debt so you don’t slip as far? Let’s take a look at emergency funds and how they can put you on the path to freedom from debt.
What is an Emergency Fund?
An emergency fund is a reserve of cash set aside for truly unexpected expenses. Most people in debt have enough to pay their minimum payments every month. But when an emergency comes along, like a sudden trip to the doctor or you get in a car crash, that sudden extra expense makes the rest of the bills fall behind. Depending on the cost and how much extra income you have, an emergency could set you on the road to bankruptcy.
But when you have an emergency fund, it creates insurance against these shocks. The more that you have in it, the more you’re able to shield yourself from misfortune.
Creating an Emergency Fund
The money in an emergency fund must be inaccessible enough that you can’t easily withdraw it, but not so inaccessible that you cannot get at it in an emergency. Money market accounts or savings accounts are common places to store one. These accounts often have penalties for withdrawing money too many times in a month. Another option is to use a checking account at a different bank than your normal one and only use cheques and online transfers with it. Bank-to-bank transfers usually take a business day at least so it will be hard to spend those savings.
Funding an Emergency Fund
How much should you put into your emergency fund? The simple rule is “the more the better.” Dave Ramsey, a big proponent of emergency funds, recommends putting in $500 as an absolute minimum and preferably $1000 or more. Most of the emergency expenditures that people encounter fall in that range. If it goes higher, the money can still serve as a buffer.
To gather the initial money for the fund, pay the minimum amount on your current debts and throw as much money as you can into the fund until you reach the desired amount. Think of it as paying yourself.
After Using the Fund
The big rule about using an emergency fund is that it must be paid back immediately. Consider your emergency fund account to be your highest-priority debt. All other debt can get paid with the minimum payment until the emergency fund is replenished. Once that is done, then you can go back to paying extra on your other debts. Think of it like fixing your airbag after a crash. You wouldn’t want to go driving again until it’s fixed, right?
Remember that an emergency fund must be used for true emergencies. Not things that you knew were coming and procrastinated on, nor things that you try to justify as an emergency (retail therapy, anyone?). If you use it right, you’ll have the peace of mind you need to throw a lot of money at your debt and not fear the future.