Your finally current on your bills and you have a budget to know where your money is going, so now what?
What would happen right now if the transmission in your car went out? Most likely, if you are just starting out, it would be a financial catastrophe. You either wouldn’t be able to afford the repair and would be without transportation or you would have to put it in the credit card, going deeper into debt.
That’s why it is so important to have savings set aside. A cash reserve meant for emergency situations that will (not might) happen. This is the next step in the Battle Plan Series.
What would you use an emergency fund for?
Let’s start off with what an “emergency” isn’t.
Christmas is not an emergency – it happens every year, the same date, meaning you have 12 months to prepare for the holiday. Here’s how to plan for your holidays.
New tires on your car (because they are bald) aren’t an emergency, you can easily check the tread on your tires or have your mechanic take a look and let you know the remaining life expectancy of your tires. Then save up for the tires.
I think you’re getting it: if you can plan for it, its not an emergency. You have to be financially responsible if you want to win this financial war.
How much should I save?
Ideally, you want to have 6-months of your monthly expenses (only bare necessities to live) in your emergency fund. But right now, most of your income is likely tied up in monthly payments to your debtors.
So, until we can free up some of that income, we are going to start with a mini-emergency fund. This should be between $1,000 – $3,000 depending on your family size (if you are single, married, kids, etc.) and income.
I know this seems like a minimal amount and you are right that it wouldn’t cover any huge emergencies (medical emergencies not covered by insurance, etc.), but its not meant to. I don’t want you to feel “safe” or “secure” until you get rid of your debt. This is only meant to ensure that you can take care of a small emergency that may come up during the first phase of this process.
Where do I put the emergency fund?
I wouldn’t recommend it laying around as cash in your house, that will make it easier to spend. You want it out of sight, but not out of reach. Just put it in a separate savings account that you can easily access if need be. Local credit unions are a great place to have a savings account.
While a money market would generate more interest, the point of this money isn’t to invest it. Its to have a stash of accessible funds in case something happens. You will invest money and make money on interest, but not right now.
How does this fit into my budget?
So, you’ve made a budget, you’ve cut your budget, you’ve found ways to increase the money you bring into the house and you are now current on all of your bills. Once you have all of your minimum expenses on your budget, anything remainder should go towards this emergency fund.
How long should it take me to save my emergency fund?
A $1,000 emergency fund should take you no longer than 6-weeks to get. A $3,000 emergency fund should take you no longer than 10-weeks. So no matter how much you are planning to set aside for this step, it should take you less than 3-months.
If when you assign the extra dollars in your budget towards the emergency fund and you won’t make it in the timeline provided, then its time to do even more cuts or figure out how to bring in more money.
What do I do once I have the emergency fund saved?
You are now ready to start tackling any non-mortgage debt you have. This is the final part of Phase 1 – STEP. If you are ready to find out how to be debt-free, then its time for the next lesson.