Ramsey recommends starting with an emergency fund of $1,000 if you are in debt, but this number may be higher depending upon your location, number of dependents and so forth. I've read that the average unexpected expense is $700 - enough to blow anyone's budget and create a debt cycle that is difficult to pay off.
Emergency Funds for Debtors
I will tackle the issue of debt in a forthcoming blog, but for our purposes, credit obligations include credit cards, debt consolidation loans, personal loans, car notes, student loans (less than $30,000) and all other types of debt excluding mortgages.
If you have any of these types of obligations, you are in debt and need to throw all your resources towards saving up a minimum of $1,000. Once that money has been set aside for emergencies, do not touch it unless you have an unexpected crisis. Should an emergency occur while you are working towards paying off debt, use your emergency fund to pay for the crisis. Do not use credit cards to solve your problems - they just create a deeper pit for you to crawl out of. Once crisis has been resolved, divert your resources to building the emergency fund back to $1,000.
Emergency Funds for the Debt-Free
If you are already debt-free, or once you satisfy all your credit obligations (except your mortgage), you can now focus on saving up the rest of your emergency funds. Minimally, you should set aside three months of living expenses and ideally six months or more. Depending upon the size of your mortgage payment (if you have one), you should be able to save up the remaining emergency funds fairly quickly now that you are no longer in debt.
How much is enough?
Money, like food, provides for some emotional needs. Depending upon a variety of factors, some will desire a bigger cushion of emergency funds than others. Calculate your living expenses for a month - don't forget to include:
- Rent or Mortgage
- Insurance (Home, Auto, Medical/Dental, Life, etc.)
- Utilities (Water, Power, Waste, etc.)
- Groceries (don't forget your pet food!)
- Incidentals (gas, public transportation fare, household supplies, etc.)
Some people feel secure if they have three months of expenses saved, others want to have a year of living expenses put aside, plus an extra cushion. There are no correct answers - it only depends on your personal circumstances. When calculating how much is enough for you (and your family) consider:
- the age of your vehicle(s)
- pending major home repairs
- age and health of pets
- age and health of dependents
- insurance deductibles
- age and condition of major appliances
Where do I keep it?
You want your emergency funds to be liquid - or in other words, easily accessible. While it is acceptable to leave the greater portion of your emergency funds in an interest-bearing savings account, ideally you can stash $500 - $1,000 in cash in a fire-proof safe. By having cash on hand, you will have funds available to pay for emergencies even when the banks are closed. Be sure to have a variety of denominations to use - not everyone accepts bills larger than $20.