Besides paying off credit card debt, it’s crucial when setting up your finances to prevent the need to rely on credit cards in the future. That means the first financial goal you should set is to start an emergency savings fund.
One of the ways credit card debt builds and becomes unmanageable is through unexpected expenses. There are some genuine emergencies where a person simply can’t go without spending money—like when you have to repair your car unexpectedly, or a broken plumbing line threatens to flood your home. In these kinds of situations, we pull out our plastic and borrow to pay off the mechanic, plumber, or other unavoidable expenses.
These kinds of emergency expenses tend to be large and because they are unpredictable, most people don’t have the funds set aside to deal with them. That’s why we stress the need to start an emergency savings fund, so credit cards won’t be necessary to get through future crises.
Here are some tips for creating an emergency fund to prevent future credit card debt:
You have to have a steady deposit into your emergency fund. It doesn’t have to be large at first. The important thing is to save something. When we help people pay off their credit card debt, our advice is to start taking the money they were sending to the credit card companies and start putting it into savings.
As long as you don’t get back into debt, you’ve got a monthly amount that you’re used to paying that can start building up every month.
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Make it Automatic
The best way to ensure your monthly savings deposit is consistent is to make it automatic. If you get direct deposit of your paychecks, see if a percentage can be deposited directly into a second account.
Otherwise, set up an automatic transfer every month so that a percentage of your income goes from your checking straight to savings. The idea is to move that money to the right place before you even notice it’s there, so you won’t be tempted to spend it and won’t miss it.
Don’t Put off Saving
If you’re still working on paying off credit cards or other debt, it’s tempting to wait to save until you’ve knocked out your debt. That said, set aside some small amount, even while you’re still making debt payments. Treat saving like a muscle you have to develop—make it consistent, automatic, and turn it into a habit that you’re not likely to break. Once you start paying off debts, then you can increase the amount you’re putting toward your emergency fund.
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Create a Budget
Most people feel like there’s no room financially to set aside money for savings. By creating a budget, there’s always a way to set aside extra cash for crucial goals.
By tracking spending for a month, you’ll see where the money is going, and immediately see some obvious places to cut back. Remember, if you’re just starting out, the goal is to save something, any amount you can. Then you can increase your savings contribution over time as you get better at budgeting and pay off debts.
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Figure Out How Much You Need
As you’re saving, you’ll want to set a few target amounts. First, your initial savings target should be manageable. A good idea is to look at your insurance deductibles. If your homeowners or renter’s insurance has a $1000 deductible, then that’s a good initial goal. Once you have that much money in savings, you’re ready for the kinds of emergencies that insurance covers.
Then, look at your monthly income. The biggest emergency that devastates people without a savings fund is loss of income. What if you lost your job, or were injured and unable to work? In these situations, the worst thing you can do is use credit cards to get by. Never use credit as a substitute for income.
The standard advice is to save up 3 to 9 months’ income in your emergency savings fund to weather a job loss or other loss of income. This is based on the statistic that the average period of unemployment is 9 months. So, assume it will take that long to find a new job and build up enough savings to get through that many months. Now, if you are a two-income family, or you have a second source of income, then 6 or even 3 months’ income might be sufficient for your emergency fund.
Keep Debts Paid Off
If you don’t have credit card bills to pay, then it’s going to be much easier to get by on your emergency fund during a period of unemployment or other lost income. If you’re having to dip into your savings to keep the creditors at bay, it will feel like all that time and effort that went into saving didn’t amount to much. Make your finances as easy to manage as you can to be ready for an emergency.
Put Extra Funds into Savings
If extra money comes your way—whether it’s from a tax refund, yard sale, gift, etc.—don’t spend it, save it. Too many people treat extra, unexpected income as a license to spend. But if you save that kind of windfall, no matter how small, then you’ll have an easier time building to your savings goals.
Don’t Touch the Emergency Fund
When is it appropriate to delve into your emergency fund? We say a bona fide emergency is a circumstance that prevents your ability to earn an income, or is absolutely necessary to your life, like medical expenses. Remember, emergencies should be unexpected.
One smart tactic here might be to put your emergency savings in an account that is accessible, but not too convenient. A credit union that doesn’t have too many branches might be a good place. Try to avoid putting your emergency fund into an account that you could access with a simple online funds transfer. But on the flip side, don’t lock it down into a 5-year CD or other accounts you can’t access if you need it.
Even after you reach your goal and have 3 to 9 months’ income in savings, keep saving. Now you can start setting “fun” savings’ goals. Plan for a family vacation, your next car, or any other thing you might want. You can also build toward a down payment for a home or a college fund for your kids… once you’ve established your emergency savings, then use the saving habit you’ve developed to work toward all of the things you want without having to rely on credit card debt to get them.
If you’re feeling overwhelmed by debt and don’t feel like you can start saving for emergencies, talk to a debt coach and put together a budget you can live with.
For tips and encouragement toward saving, check out America Saves, and consider taking the pledge to save.
No matter what your financial situation, creating a sufficient emergency savings fund is absolutely essential to your financial health. It will help you become a better saver, avoid future credit card debt, and achieve true financial freedom.