What is an emergency fund?
An emergency fund is money that’s set aside for unplanned expenses, such as a medical bill, home repair or loss of income. Using emergency savings to cover unexpected expenses is better than paying with high-interest credit cards or taking out a loan.
Why an emergency fund is so important
An emergency fund is an essential part of a solid financial plan. Emergency funds allow you to cover unexpected expenses without having to use high-interest credit cards or take out a loan. That’s why the time to start saving for an emergency is today.
“By nature, unplanned expenses are unexpected, so the sooner you’re prepared the better off you’ll be when the inevitable happens,” says Greg McBride, CFA, Bankrate chief financial analyst.
People normally build up an an emergency fund to help them during some of the following unexpected events:
- Unexpected medical expense.
- Unforeseen living expense.
- Emergency home repair.
- Sudden auto repair.
- Death in the family.
How much to save in your emergency fund
An emergency fund should be big enough to cover three to six months’ worth of expenses.
Saving that amount of money may take a while for some people. Make small goals at first, such as saving $1,000, and then work your way up to a reserve to cover several months’ worth of expenses.
Your specific savings goal will depend on your income and expenses. When setting your savings goal, focus on having enough to cover expenses, not on replacing your entire income.
A sole breadwinner, a business owner or a person with a highly variable income might want to aim for nine or 12 months’ worth of expenses in their emergency savings account.
Where to keep your emergency fund
The best place to keep your emergency fund is in a high-yield savings account. These accounts offer quick access to the money and pay a competitive yield. Look for banks and credit unions that insure deposits through the FDIC or NCUSIF.
Online banks are good options for your emergency savings because you can’t just walk into the bank and withdraw your cash. Online banks also typically offer higher yields than brick-and-mortar banks. Compare rates on Bankrate to find the right account for you.
Sometimes there’s more to choosing a bank than just the rate. In these instances, use Bankrate’s bank reviews to compare features and find the right bank for you.
6 easy steps to get your emergency fund started
1. Make a budget and see where you can start saving more money
It’s important to know where your money is going so that you can find saving opportunities. Without budgeting, you won’t be able to maximize income and find ways to reduce or manage your spending. You can use Bankrate’s Home Budget Calculator to set your budget up.
You can also use a budgeting app. These apps will calculate your spending and earning for you so that you can get a dashboard view of your financial situation.
You can sign up for Bankrate’s myMoney to categorize your spending transactions, identify ways to cut back and improve your financial health.
2. Determine your emergency fund goal
You’ll determine this number from looking at your budget and calculating how much you need each month to cover essential expenses. Rent or mortgage, food and transportation are some of these necessary spending categories.
3. Set up a direct deposit
Set up a direct deposit that takes a portion of your paycheck and automatically puts it into your emergency fund. This will help you regularly save since you won’t be tempted to spend it rather than transfer the money on your own.
4. Gradually increase your savings
Over time, increase the amount you’re contributing to your emergency fund by 1 percent or a specific dollar amount. You might not even notice a small increase in savings missing from your checking account. Do this regularly until you’ve reached your savings goal.
5. Save unexpected income
At least a part of any windfall that you receive should be used to fund an emergency fund, unless you already have a sufficient one established. Unexpected money can come in the form of a tax refund, bonus, cash gift, inheritance or winning a contest or the lottery.
6. Keep saving after reaching your goal
Emergencies may require more than a six-month cushion. In these situations, you’ll be relieved to have this extra money on hand.
Being unemployed for more than a year or being hospitalized for many months are both situations where you’ll be glad you have more in your emergency fund.