Sure, it would be nice to pay for unexpected expenses without pulling out a credit card, but that’s easier said than done, right? The secret to paying out-of-pocket to replace a refrigerator, that has lost its cool, is to build an emergency savings fund. Having money set aside for emergencies can help prevent you from going into debt when they arise.
Your emergency fund should be accessible on short notice, yet not so convenient that you’re tempted to spend it on other things. In other words, don’t connect it to your checking account. Better yet, set up an account at a bank that’s separate from your everyday bank. This reinforces the idea that the fund is for emergencies only.
With an emergency savings fund established, restrict withdrawals to unexpected emergency expenses only. Dipping into your fund for any other reason will only defeat the purpose of having the fund, and may leave you empty-handed when a real emergency does arise.
Before using your emergency fund to pay for something, ask yourself three questions:
- Is the expense unexpected? – Your emergency fund shouldn’t be used for every big expense that comes along. For example, a six-month auto insurance premium can be a hefty bill, but since you know when it’s coming, it’s not unexpected. It’s something that should be budgeted for along with your other regular expenses. On the other hand, needing to pay your auto insurance deductible after a car accident is an unplanned expense.
- Is it necessary? – If you break your leg playing football, a trip to the emergency room can be costly, but it’s necessary. A trip across the country to go watch your favorite team play in the Super Bowl may seem like a “can’t miss” opportunity, but it is not necessary.
- Can it wait? – If your apartment building has a fire or flood, you may need to find a new place to live in a hurry and incur moving expenses that can’t wait. But that doesn’t necessarily mean you should convert your entire emergency savings fund into a down payment on a house.
If the answers to the first two questions are “yes”, and the answer to the third is “no”, then it’s okay to use your emergency savings to pay for the expense. That’s why you have an emergency fund. If the answers to the first two questions are “no”, and the third answer is “yes”, you may want to reconsider dipping into your emergency fund.
Emergency expenses are inevitable and will occur throughout your life. However, with an emergency savings fund, you will be better prepared to respond when they do occur. Plus, the fund will help you cover the expense without putting yourself underwater with debt.