A lot of personal finance advice starts out with “Everyone needs an emergency fund”. A survey in 2016 showed that a third of middle-class families couldn’t pay an unexpected bill of £500 without borrowing, so the lack of savings is a very widespread problem.
But what if you already have debts that you are paying off? Accumulating an emergency fund will delay clearing the debts and increase the interest you pay on them… but having a rainy day fund will make it a lot easier to stick to your budget. This is another of those areas, like deciding how far to cut back, where you have to find the right balance that suits you.
This article looks at deciding if you need an emergency fund and how large it should be. It’s aimed at people who are making the monthly payments to their debts – if you can’t afford to do this, look at different debt solutions such as a debt management plan.
Do squirrels have an emergency fund?
In autumn, squirrels start putting aside nuts to eat months later – is this an emergency fund? Every year the weather gets worse and the available food sources run out. Squirrels that don’t have a hidden hoard may get through a very mild winter, but in an average or cold winter, they are quite likely to die.
This is much like putting money aside for car insurance, Christmas or getting new shoes for the kids. Sometimes you know the exact date and amount, sometimes the date is uncertain or the amount can vary, but you know some money is going to need to be paid sometime in the next year.
Your budget needs to include all the things you know are going to happen, with your best guess at the date/amount. Then you need to put aside the money for those every month, even if it isn’t needed that month. An emergency fund is meant for the things you don’t expect to happen. So the squirrel’s saved nuts aren’t really an emergency fund at all, just good planning for the next few months!
What could go wrong?
Three or six months income is often suggested for an emergency fund. For most people with problem debts, this just isn’t going to happen! And anyway what matters is not how much you earn, but the type of emergencies you are exposed to:
- if you are in private rented accommodation, then you won’t have to pay for boiler repairs, replacing washing machines etc. Your main emergency is likely to be having to move at the end of your contract, or at two months notice if your fixed tenancy has already ended. Of course, you should get your deposit back, but sometimes things go wrong;
- in council or housing association property, you shouldn’t have to move but may have to replace white goods;
- if you have a mortgage, your main risk is probably losing your job, in which case you won’t be able to get any help with the mortgage costs from the benefits system for 39 weeks, and it may be limited. Other risks are the boiler (how new is it?), repairs (roof? guttering? plumbing?) and replacing white goods;
- cars can be money pits :( You need to know what the excess amount is on your insurance. You should have a sensible amount in your regular budget for routine maintenance. But if your car, like mine, is nearer to becoming an adult (18+) than a toddler (under 4), then there may be a time when it’s not economic to repair and has to be replaced;
- family abroad? Your major risk could be the cost of flying back, for example for a funeral; and
- vets’ bills (thank goodness in Britain we don’t have medical emergencies on this list!)
So how much does that add up to? That’s going to depend on how many of the above factors affect you – and you can’t plan for everything going wrong at the same time, even though it’s possible the dog will break a leg, your car will need a new engine and the roof will start leaking all in the same month. For most people I would say it’s somewhere between £250 and £2,500 – towards the bottom if you are renting and don’t have a car, towards the top if you have a mortgage and a car.
The alternatives to a cash emergency fund
But you don’t have to have all that money available in cash:
- do you have a credit card with a lot of unused credit? Dipping into this regularly is going to mean you never clear your debts, but in a real emergency it can be vital;
- are you paying a lot more than the minimums to your debts each month? If you are overpaying by several hundred pounds or more, then if the fridge has to be replaced, you just use that month’s surplus debt repayment to buy a new one;
- do you have a lot of discretionary expenditure each month? New clothes for adults, swimming lessons for kids, eating out – they can all go in a tight month;
- is there insurance cover for unemployment or the boiler? But check what the insurance is costing you! It’s possible to pay out a lot every month if you have lots of small insurances – boiler cover, plumbing emergency cover, pet insurance; white goods cover – it might be better to cancel all of them and save up that money into an emergency fund;
- does your partner have a good job? Single people or people with non-working partners are much more exposed to job problems. If you have a well-paid partner with no debts and you are trying to clear yours as fast as possible, it may be a good idea to run with no emergency fund, on the understanding that your partner will help if there is a crisis;
- have you got a spare room that you could rent out? You may not want to, but if you’ve lost your job, then it’s going to help pay the mortgage until you get more work;
- is your job really secure or would you get a good redundancy pay out? If the chance of losing your job is very small, it may be better to pay off your debts as fast as possible.
So this doesn’t have to be an all in cash or nothing decision. You might decide to save up a £500 emergency fund in cash by putting aside £50 a month, knowing that whilst you are accumulating this you can use a credit card if a big problem crops up. And after you have your £500 buffer, the card is still there for a major crisis.
Partly this depends on how it is going to take to clear your debts. If it’s just a couple of years, then you may feel you can run the risk of not having an emergency fund in cash, because as your debts are paid off so the amount you could borrow in a crisis rises. But if you know its going to take quite a few years, then it’s best to be realistic – something unexpected is going to crop up, probably more than once, and having a good emergency fund will give you confidence that you can stay on track.
Don’t save too much if you have debts!
This may provoke hollow laughter … but some people do have several thousand pounds in the bank “just in case” and large debts. This is more like a comfort blanket than an emergency fund. Think of at least halving it and paying a lump of your most expensive debt.
How to save it
Think about some combination of these three approaches:
- put some money aside as soon as you get paid so you aren’t tempted to fritter it away during the month;
- if you ever get a bonus (some extra overtime?) move half of that into savings and spending the other half, or clear some debt with it;
- get an automatic savings app, that move small amounts of money aside during the month that you won’t miss. I have reviewed two and they are both simple to use and clever at helping you save painlessly.
Where to save it
Somewhere you can get it out easily but not too easily! Having to give notice of a month or more is useless, the whole point about an emergency is you don’t know when it is going to happen. But an easy access savings account with your bank, where a click of a mouse can move the money back into your current account might be a little too tempting if you think you could be in danger of dipping into it when you see a bargain pair of shoes in a sale.
One good place could be a credit union account. You may be eligible to join one based on where you live or work, or through the type of work you do, see Find Your Credit Union. They have the big advantage that if an emergency does happen and you don’t have enough saved, you may be able to borrow more money from them at a reasonable rate of interest.
Another place could be an easy access ISA account. So you can get your money if you need it, but it’s just a little bit harder than an instant transfer into your current account.