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Tuesday, February 5, 2013

Why do I need an emergency fund?

Why do I need an emergency fund?

By Sarah C.

Now that you have a regular budget, consider earmarking money each month for an emergency fund.  This money should be set aside in a savings account that you don’t touch for regular monthly bills.  Instead, it’s there when something unexpected arises – like an unforeseen car repair, or medical bill, or job loss.  Rather than going into debt by using a credit card or loan, your emergency fund allows you to pay for the expense without derailing other financial goals. 


For example, if you charged a $1,000 emergency with a credit card that carries an 11% interest rate, and repaid the minimum payment ($40), it would take six years to pay off the debt, and you would have paid $258 in interest.  That’s six years of paying for yesterday’s problem and not being able to plan for the future.  Not to mention the other things you could have done with the $258.


Ideally, your emergency fund should have enough money to cover 3-6 months of living expenses.  That can be an intimidating number when you’re starting off, especially if you are also paying off debt.  So start with a goal of $1,000.  Then, when your other debts are paid off, work on increasing your emergency fund so it can cover you for a few months just in case.


When you’re living paycheck to paycheck, it can seem impossible to find extra money to fund an emergency fund.  But that’s when you need it the most, because the impact of any financial set-back – extra debt, higher interest rates, etc. – is amplified in a tight budget.   Knowing you have money available can also reduce personal stress you feel about finances.  Tax refunds are a great way to jump-start an emergency fund, so if you’re expecting money from the IRS this year, pledge to put some aside for emergencies.