Life is uncertain and there will be times when you will need some extra money to deal with an emergency. This is where the emergency fund comes in.
An emergency fund should be easy to access and should be used only in case of an emergency. Personally I like to keep my emergency fund in a good old savings account. It doesn’t earn much interest, but I can access it very quickly in case I need some extra money.
Why you need an emergency fund
Younger folks might think they don’t need an emergency fund. It’s too easy to charge the expense to a credit card, but that’s a surefire way to build up high interest credit card debt. For us older folks who have been out on our own for a while, we have been through many expensive situations, such as:
- The car overheated and broke down completely and the repair costs would have been more than a new car;
- The rental property needed new exterior paint and drainage repairs;
- I had a dizziness issue and needed to see many doctors including a specialist; and
- I quit my job.
These are just a few of the emergency situations that can cost many thousands of dollars. Those who don’t have an adequate emergency fund can easily run into trouble when such situations arise.
How much should you have in an emergency fund?
Most experts recommend that families save 3 to 6 months of living expenses, but you need to examine your own financial situation to see what’s right for you. If you just graduated from college and are living with your parents, then perhaps $1,000 is enough. However, if you have a house, a kid, 2 cars, and other obligations, then you probably need much more. We saved up $50,000 before I quit my job because we wanted to be certain we could weather the reduction in income for at least 2 years. Track your expenses and see what make sense for you.
When your emergency fund is not enough
What happens if your emergency fund isn’t enough to cover your emergency? If you have $1,000 in your emergency fund and totaled your car, then that won’t be enough to replace your vehicle. What are your options at this point? You still need to get to work.
- Borrow from yourself. If you really need cash, perhaps you can borrow from your 401(k). Or if your house has some equity, then talk to the bank about a home equity loan.
- Borrow from the bank. It’s pretty easy to get a car loan from the bank if your credit is good. If you need money for other reasons like paying a medical bill, then the bank can also arrange a personal loan if you qualify.
- Peer to peer lending. A relatively new source to borrow money is from people just like you. You can sign up at Prosper.com and see what kind of interest rate you can get. The better your financial situation and credit scores are, the better interest rate you will get.
- Credit card. You can also get a cash advance from your favorite credit card companies, but the interest rate is quite high.
- Family. One last option is to borrow from family. I would avoid this as much as possible because you don’t want money issues to come between you and your family. If you decide to borrow from them, then draw up an agreement to make it official.
These are just a few sources where you can turn to if your emergency fund runs dry. You need to be honest with yourself and figure out how much you really need in the emergency fund. As your obligations and expenses grow, make sure you increase your emergency fund to prevent a financial slide.
photo credit: flickr insurewish.com