People bundled up walking down the street
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Stephen Nelson awoke to disaster.

When he heard a dripping sound from the second-floor bedroom in his southern California condo at 4 a.m. last June, he thought the sink was leaking. Unfortunately, his water heater had ruptured, causing water to cascade down the ceiling, ruining pretty much everything in the room.

“For a second, I wished I could crawl back in bed,” says Nelson, 26, who ended up paying $2,000 in out-of-pocket costs, with homeowners insurance covering the rest.

Millions of Americans can relate. More than one-third of households, 34 percent, endured a major unexpected expense over the past year, according to Bankrate’s latest Financial Security Index survey, with only 39 percent saying they would cover a $1,000 blow with savings.

When calamity did strike, the average expense was more likely than not to cost at least $2,500, illuminating the importance of stuffing a high-yield savings account with three to six months worth of spending.

“Unplanned expenses can pop up at any time, and your best protection is having an emergency savings cushion,” says Bankrate’s chief financial analyst Greg McBride, CFA. “Not only are returns on savings accounts rising, but it acts as a buffer from high-cost credit card debt or other borrowing.”

Life happens. Are your finances prepared?

While tapping savings to pay off an emergency was the most common response, more than a third of Americans would sink into one type of debt or another, potentially harming their financial security. Almost 1 in 5 would pay with a credit card and finance the balance over time; 12 percent would borrow from family or friends; and 5 percent would use a personal loan.

fsi-index-jan-2018

A sizable chunk of consumers seemingly haven’t seriously considered what they’d do in case of a crisis. One in 8 would count on reducing spending from other parts of their budget, 6 percent would resort to something else and 4 percent simply don’t know.

Lower wage earners, those making less than $30,000 a year, were twice as likely to use some form of borrowing than savings, while households making more than $50,000 were more apt to use cash.

This result dovetails with a recent Federal Reserve report that found 44 percent of Americans couldn’t cover a $400 emergency expense out of their pocket.

“The survey findings remind us that many American households are struggling financially, including fully 40 percent of those with a high school diploma or less,” said Federal Reserve Board Governor Lael Brainard.

Save more in 2018

Kristen Hicks heard noises in her attic. Remembering that her home inspector noted droppings before she bought the house a few years ago, Hicks, 32, soon learned that she had a rat and squirrel situation. The total bill to get rid of the vermin and make sure they never came back? $900.

Hicks, an Austin-area freelance copywriter, used her “house fund” to get rid of her furry guests and patch up other home issues. She contributes a couple hundred bucks every month to the fund.

“I’m lucky,” she says. “I’ve been adding to it for a while.”

And you should, too. With the Federal Reserve pushing up short-term interest rates three times last year, and looking to repeat the feat in 2018, savers will finally start to see a bit more yield in their savings and CDs after the central bank took extreme measures following the Great Recession. Borrowers, however, will see interest on their debt continue to nudge upward.

Meanwhile, wages are starting to perk up, and the recently passed tax bill should put a few extra dollars in your pocket.

How to build an emergency fund

Timothy Wiedman had around $25,000 in his emergency fund in September 2016 when he slipped on wet grass on the way to his car in the middle of the night and ended up in the hospital with a separated shoulder. The recently retired Doane University associate professor shelled out around $1,700, despite driving himself to the hospital. He was able to cover the hospital bills out of savings rather easily.

Amassing such a large cache is no easy feat, especially as health care and college costs rise dramatically.

The trick is to take it slow and redirect new income into your savings account. Start by trying to account for one month of expenses and go from there. Don’t go after six months all at once; you’ll soon get discouraged.

Pay down debt judiciously, and once the balance hits zero, allocate the monthly contribution you were paying the credit card company to your savings account. Do the same thing whenever you earn a raise, or if a fixed cost, like a car loan, fades away.

And don’t force yourself to remember to contribute every month. Automate.

“Build your savings cushion by having a regular direct deposit into a dedicated savings account,” McBride says. “Even when unplanned expenses arise, you’re only one paycheck away from beginning to replenish that savings cushion.”

The economy is on the rise, and the cost of debt will only increase. The time to save is nigh.