Recently on our bankruptcy forum a user asked, “I have heard for years that I need a three to six-month emergency fund which can cover my living expenses., I have very high student loan debts, a $10,000 credit card bill and secured assets which are costing me a great deal of money. What are your thoughts? Should I pay off my debt or start to save for my emergency fund?”
The truth about an emergency fund
For years, financial experts have touted the benefits of having an emergency fund. The argument was that in time of unemployment, a recession, unsteady income, disability, death or divorce those thousands of dollars might be all that stands in between you and financial ruin.
While all the above factors are a real and present risk, there seems to be a new argument from some that the emergency fund may not only be unnecessary- with the assumption that there are better ways to spend or save your money- but that most Americans have much more serious concerns.
For example, it’s estimated that Americans have more than one trillion dollars in student loan debt. Other households are carrying upwards of $15,000 of debt on their credit card each month. With this much unsecured debt costing anywhere between15- 20%, it does not make sense to put your money into an account that pays little to no interest without first paying down other high interest debts.
Steps to take before creating an emergency fund
So, before jumping on the emergency fund bandwagon there are some common sense steps that some advisors suggest.
- Pay off high interest debts.
Before you save any substantial amount of money into an emergency fund, it is generally a good idea to pay off your high interest debts first.
So, what does this mean for you? You need to concentrate on eliminating your student loan and credit card debts before deciding how much of a cash reserve you need to save. This means creating a budget and living below your means. Do not buy things you cannot afford. If you are a parent, do not impoverish yourself so your kids can attend college.
- Look for additional ways to protect yourself.
What if you lose your job or have a serious accident? Of course, you need adequate protection against common catastrophes. The good news is there are some commonsense steps you can take to protect yourself.
For example, if you are afraid of not being able to work due to disability, determine if a short-term disability policy can protect you. If you are concerned you might have a car accident, review your car insurance policy and insure you are adequately protected.
- Consider using existing credit if you have a true emergency.
If you are repaying your high interest debts each month you may not have a lot of extra cash. So, what do you do if you have a true emergency? Fortunately, in many cases you might be able to use your credit card. While this might not be the best option for customers who have had their credits lowered by the banks, some customers may be able to access more than $20,000 in a true emergency.