Emergency Fund FAQ

Prepare and prevent. Don’t repair and repent.

~ Author Unknown

Update: This post is featured in the Carnival of Financial Planning – Edition #135 posted at The Skilled Investor. Thank you!

I’ve mentioned emergency funds quite a bit but I’ve never given them the thorough treatment they deserve. I thought I would try an FAQ (Frequently Asked Questions) format to provide you with some information and options.

What Is an Emergency Fund?

An emergency fund is a reserve of cash that you set aside for unexpected expenses. This usually applies to things that break: your car, your appliances, your furnace or other items in your home – or maybe even an arm or leg. (Sometimes you have to pay for certain types of casts or splints.)

You may also want to build an emergency fund to cover higher future mortgage costs. If you are on a variable rate, you may want to have a cushion in case rates rise. If you have a very low fixed rate mortgage, you may have to renew at a higher rate later. It pays to use a mortgage calculator ahead of time to make sure you’ll be able to cover your new payments.

Why Should I Have an Emergency Fund?

An emergency fund can give you peace of mind and keep you from incurring debt and the extra costs that come with it. You will avoid both stress and interest.

Should I Pay Down Debt or Build an Emergency Fund First?

There is some debate on this issue, but I come down on the side that says you should have at least a minimum emergency fund of $500 – $1000 before you attack your debt. This will keep you from incurring more debt if your dishwasher breaks down or you blow a tire.

If you know your washer and dryer are on their last legs, you may want to save enough to cover a new set. (See my article on Preemptive Purchases.) If your car is likely going to need brakes over the next year, you can save for that in advance too. Once you have paid down your consumer debt, I would suggest padding your emergency fund to protect against job loss.

How Much Should I Save in My Emergency Fund?

Again, there’s a lot of debate over how much you should save. In the end, it’s your call. Once you have saved the minimum amount ($500 – $1000) and paid down your consumer debt, the exact amount you need to save depends on your situation.

If you have a very stable income, you may only want to save enough to cover expenses for a month or two. If your income is variable or you are worried about losing your job, you may want to build up a 6 month cushion, or even more if it helps you sleep at night.

Is your home due for a new roof? What is the life expectancy of your vehicles and appliances? How accident/illness prone are your kids? If you have young children who tend to get sick frequently, you can incur elevated costs for prescriptions and/or over-the-counter medications.

Obviously, you can’t predict every possible expense. That’s sort of the point of the emergency fund. But you can arrive at a better ballpark figure if you have a good handle on what might go wrong. Every year when I set up our budget, I ask my husband for rough figures on car care and home maintenance expenses and then I budget a little above that just in case.

Where Should I Keep My Emergency Fund?

Your emergency fund needs to be easily accessible. We basically have two emergency funds. We keep the largest portion in a high interest savings account. We also keep a cash cushion on hand at home in case we can’t make it to the ATM (or the ATMs are down) or we just need some cash for unexpected expenses like field trips or fundraising for the kids’ schools. I track this cash and it gets replaced as soon as possible.

We’ve held a number of garage sales over the years and I usually use the proceeds of those for the cash portion of our emergency fund. It helps to keep some smaller bills, loonies, and toonies on hand from these sales for school expenses like those mentioned above. (Exact change is often required.) I can’t tell you how many times I’ve been grateful for our garage sale cash box when I’m rooting around for $3.75 for a hot dog day or some other event.

When Should I Use My Emergency Fund?

Your emergency fund should be reserved for true emergencies. An unexpectedly good deal on a vacation package doesn’t count. If you use your fund for things like that, it won’t be there for you when you really need it. If you’ve been around awhile, you know that Murphy’s Law says that you’ll have a fender bender or some other bit of bad luck right after you’ve booked your cruise.

Set some rules for yourself and follow them. Write them down if you don’t trust yourself or your significant other to stay disciplined. When you want to tap your emergency fund, whip out your list of rules and see if your proposed purchase fits. If it does, go ahead and spend the money. If not, you’re either going to have to do without that item or wait until you’ve saved enough to buy it without debt.

If you need to use some of your emergency fund, take some time to re-evaluate your position afterward. You’ll probably want to take some time to replace that money so that you’ll be ready for the next emergency.

How do you handle your emergency fund? Do you have any good tips to share?