Simply put, an emergency fund is money set aside for life’s unexpected events. And yes, you can have an emergency fund even with debt. Personal money-management expert Dave Ramsey suggests saving a starter emergency fund of $1,000 first. Next, you should pay off all of your debt (cars, credit cards and student loans) except your mortgage. Once you have paid off your debt, take that money and build a fully funded emergency fund that covers three to six months of your expenses.
It is possible to build a starter emergency fund without much sacrifice. Make saving a game, and track everything you spend money daily, weekly and monthly. This simple exercise will show you what you may be able to go without.
Cut debt by cutting unnecessary expenses.
Ask yourself, do you really need to spend money on this or that? For me it was a CSA membership and annual passes. Discern if it’s really worth the money (and the time, energy and gas). It was a hard choice not to renew these memberships, but realizing I didn’t need to spend nearly $800 for both of these has allowed me to set the money aside for something else.
Reduce spending allowance.
We’ve reduced our weekly family “fun money” spending by $10 a week over the past five years. So by cutting out two venti espresso drinks from our weekly spending, we saved $520 a year, or $2,600 over five years. This is a staggering amount and money that can be used or saved for something else much needed for the house or kids.
Of course, you don’t have to say goodbye to these treats forever. You can cut unnecessary expenses until you’ve established your emergency fund, and once it’s at your recommended level, keep it safe and forget it. Recommended level means you should have three months of living expenses. So if you need $3,000 a month to cover your basic needs like mortgage/rent, utilizes, gas and food, then you need $9,000 in your established emergency fund.
Once you are at Dave Ramsey’s Baby Step 7: Build Wealth & Give, and your house is paid off, you may want to keep one month of expenses in checking at all times (ensuring that the balance never goes below that) and six months of expenses in a HELOC that can be drawn on if needed.
No matter what stage you are at in creating your emergency fund, having a little nest egg for life’s curveballs will give you financial confidence, and most importantly, you won’t fall back into the debt cycle.