Are you ready to pay off your debt but have no clue where to start? Read the first post in my series about paying off your debt, then read through this series until you get to this post, our sixth in the series.
I bet you’re excited about the money you’ve been saving by paying attention to the little things and you’ve been wanting to know what you’re supposed to do with it. Well, today’s your lucky day, because what you need to do with the money you’re saving is to set up a small emergency fund BEFORE you start paying off your debt.
It might seem counter-intuitive to put money in a bank account that earns less than 1% interest when you’re paying even more interest on your debt, but it makes perfect sense based on the mindset you’ve been adopting throughout this series. The goal is to completely change your life and pay off your debt for good. Having a small emergency fund gives you a much better chance of making that a reality.
Why You Need A Small Emergency Fund
Our goal is to completely destroy any consumer debt you have while never incurring any additional consumer debt. With that in mind, does it make sense to have no funds available for unexpected emergencies? If an emergency pops up that you have to pay for immediately and you’ve spent every penny you have paying off your debt, how would you pay for that emergency? You’d have to incur more debt to pay for your emergency and that’s exactly what we want to never happen again.
You might want to argue that it doesn’t matter if you incur just a little bit more debt for the emergency because in the end, you’ll still pay less in interest by not having an emergency fund. That may be true for the most dedicated debt destroyers, but for the majority of people you’d probably be wrong. Why? Because paying for your emergency with more debt breaks all of the good habits you’ve practiced since swearing off consumer debt for good.
Once you break out the credit card just one time to pay for your emergency, you remember how it feels to swipe the card and not have to immediately pay for the purchase you just made. This is dangerous territory for anyone who has gotten into serious debt. You don’t want to take any chance of relapsing into your old consumer debt incurring ways.
The small emergency fund will allow you to pay for most emergencies with cash. This will keep you from breaking out the credit cards and it will prevent you from taking the chance of relapsing into debt incurring bad habits. What happens when you use some of the emergency money? Simply pause your extra debt payments and rebuild the emergency fund to your desired amount. Which brings up a great question. How big should your small emergency fund be?
How Much Is A Small Emergency Fund?
The amount of your emergency fund should be specific to your personal situation. Some people with very few expenses could probably get by with an emergency fund as small as $500. If you have a more average budget, I’d probably go for about $1,000 to $1,500 on the high end. Of course, if you’re seriously worried about debt relapse, the absolute most I’d recommend is one month’s worth of expenses.
The key when deciding on the amount of your emergency fund lies in how expensive some of unexpected items would be for you. If you got into a car accident, what is your auto insurance deductible? If you had a medical emergency, what is your health insurance deductible? If you have a car that’s slowly biting the dust, how much do you think it’d cost to get your car running again? Try to think of the possible emergencies that would prevent you from your goal of never going into more consumer debt again and choose an appropriate sized emergency fund.
Just remember, only choose a number big enough to get by. You don’t want a ton of money sitting in cash only earning 1% or less when you have credit card debt interest racking up at 20% or more. You don’t need to have an emergency fund large enough to cover big emergencies like job loss yet, because if something that large happened you’d have much bigger problems than trying to pay off your debt as fast as possible. Once you’ve paid off your consumer debt you can work on building your emergency fund to a larger level to cover these types of emergencies.
Don’t Use Your Emergency Fund For Fake Emergencies
One last note about the small emergency fund you’ll be building. Don’t use it for fake emergencies. Doing so is just as bad as incurring more consumer debt. Finding a great deal on a vacation or an item you’ve been wanting forever is not an emergency.
An emergency is only something that threatens your life, your health, or your wealth. A broken down car that can’t get you to your job threatens your wealth. A car with a broken air conditioning system doesn’t. Know the difference and don’t use your emergency fund on fake emergencies.
The next step in your debt pay off journey is to learn about the different debt pay off methods. We’ll start with the debt snowball method.
Are you already on your way to completing your E-fund? How much will you keep in it? Have you ever had to use your emergency money? I want to know all about you and your adventures on building your cash stash. Leave a comment down below!
Picture by: 401(k) 2013 Text added by: Lance Cothern