If you don't have an emergency savings fund, how can you handle unplanned expenses? The answer is incurring debt, possibly at a level that you may not be able to handle.
Greg McBride, Chief Financial Analyst at Bankrate.com, refers to an emergency savings account as "the buffer between you and high-interest debt."
A good rule of thumb is to have 3-6 months' worth of expenses available as a cash buffer to handle unexpected expenses or temporary loss of income. Unfortunately, the recently released HomeServe Biannual State of the Home Survey revealed that far too many Americans lack a sufficient emergency savings fund. Almost one-third (31%) of survey respondents had less than $500 as a cash buffer for unexpected expenses, and 19% reported having no emergency savings at all.
The survey did find some level of preparedness, especially among older Americans. Just over one-quarter (26%) of survey respondents reported having at least $8,000 set aside in an emergency fund, with 48% of those older than age 65 having $8,000 or more compared to 20% of those from ages 18-64. Perhaps older Americans are expecting more unplanned expenses such as medical concerns, or this data could reflect education from the school of hard knocks.
The survey also asked Americans to predict the types of unplanned expenses that could affect them over the next year. Almost half (49%) anticipated medical emergencies, while 52% expected that car troubles would cause financial woes. Home repair emergencies were cited by 42% of respondents as a potential drain on funds.
It's not necessarily bad to take out loans or incur debt, but the point is to manage your debt and not become consumed by it. Without an emergency fund, you can easily get into a situation where a surge of high-interest debt can place you in a debt spiral. Interest charges can pile up and make it increasingly difficult to climb back out of the hole.
Are you having trouble creating or maintaining an emergency fund? McBride suggests starting with a budget. "Force yourself to keep track of your expenses, calibrate the amount you're bringing in on your net income with what's going out the door. This is really your scorecard to tell you whether or not you're living within your means."
Tracking expenses is a critical part of gauging your needs. It's hard to tell how large your emergency fund should be if you don't know how much you regularly spend. When you do set up your budget, don't focus solely on monthly expenses and forget semi-regular or annual expenses like insurance and property taxes.
If your budget tells you that you aren't living within your means, readjust your budget — and carve out some space for an emergency fund. "Even if it's just $10 a week, that's something," says April Lewis-Parks, Director of Education and Public Relations at Consolidated Credit. "People feel like it's such a little bit of money, it won't help...but truly, have it become a habit and keep doing it week after week, month after month, year after year, so you have a cushion." Once contributions to an emergency fund become a habit, they won't seem like such a burden.
Take Lewis-Parks' advice, and you will be surprised at how your emergency fund grows. You will also be grateful that the fund exists when you can pay off the unexpected expense instead of whipping out the credit card and worrying about how you will pay off your new debt.
If you want to reduce your interest payments and lower your debt, try the free Debt Optimizer by MoneyTips.