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Woman Scratching Head in Front of Broken Car Hood

Emergencies happen and you need to be prepared. If you were to have the transmission go out on your car, how would you pay for it? Would you put it on a credit card? If the emergency cost you $2,000, how long would it take you to pay off that card?

According to CreditCards.com, the average credit card rate in the United States is 14.97%. That can make having an emergency more stressful, knowing that it could potentially cost you  more if you can’t pay the card off right away.

What is the solution then?

An Emergency Fund (a.k.a Rainy Day Fund)

Definition: an emergency fund is an interest bearing bank account that you put money in and just let it sit there and it’s sole purpose is to be the go-to source for cash when emergencies arise. It is not a “lets take a trip to California” fund, it is more of a “oh no, my car just broke down” fund.

What constitutes an emergency?

Anything that happens that is not in the budget and that needs to be addressed would be considered an emergency. For example, when Kim and I first got married, we had two condos. One was a rental and the other one we lived in. Within the same year we had both hot water tanks go out which cost us over $1,000 to fix. But because we had an Emergency Fund, we were able to pay cash right away to have them both fixed and didn’t have the stress of figuring out where we would get the money.

How much is enough to keep in your Emergency Fund?

It depends on where you are with your finances. If you have debt, I would say $500 would be good and is what I call a Starter Emergency Fund. If you make more than $40,000 per year, you can  increase your’s to $1,000. Then pay off all of your debt, smallest to largest (see previous post on how we paid off $52,000 in debt in 18 months). If you are debt-free except for your house, you should have a minimum of 3 months worth of living expenses. For instance, if you spend $2,500 per month, then you should have $7,500 sitting in an interest bearing savings account.

Don’t people say to have 3-6 months worth of expenses?

Yes, but I like to have smaller attainable goals. Ask yourself, how many people do you know that even have 3 months of expenses in a Emergency Fund? The goal is to have cash reserves to cover most emergencies that come your way. Now, if you foresee a job loss or know of potential expenses that could exceed 3 months, than by all means, increase the amount that you set aside.

Where do you keep an Emergency Fund?

The best place to keep the money is in a high yield money market account. There are several options out there, but if you are looking for a place worth checking out, read my review of Everbank where we currently keep our emergency fund.

Once the Emergency Fund is tapped out, then what do you do?

Fill it back up. Take the surplus, or the money you have left over after paying all of your bills, and begin replenishing your account until it is full again. If you are living paycheck to paycheck, like most broke people, and feel like you don’t have any surplus, check out ways to earn extra cash or ways to trim your budget.

Have you had an emergency recently? If so, how did you pay for it?