Why do I need an emergency fund?
An emergency fund is a lump sum of money saved up to cover unexpected costs, such as loss of income, or paying for car repairs or a new boiler. Saving an emergency fund can give you a safety net to fall back on. And it could remove the stress of having to borrow money if the unexpected happens.
Five steps to starting your emergency fund
The following five tips can help you kick-start your emergency fund:
1. Work out how much you should save in an emergency fund
Work out how much you’ll likely need to cover potential emergencies. Think about how much you spend on day-to-day expenses, such as how much running a car or household bills could cost. Considering these types of questions will help you work out how much you might need to save.
The general rule of thumb is to have at least three months’ worth of living expenses saved in an emergency fund. This should cover essential costs, such as rent or mortgage payments, household bills and food. Some financial experts suggest saving six months’ worth of expenses if this is possible. Of course it all depends on your individual situation and what is possible for you as well as how much peace of mind you want.
Further to this, setting up a standing order or direct debit ensures that you consistently save the amount of money needed to reach your goal.
2. Create a budget
Set weekly and monthly budgets to make sure you can manage all your regular expenses: rent or mortgage payments, travel, socialising, childcare, utility bills. In addition, your budget should ensure that you can still afford to save for your emergency fund.
Budgeting carefully allows you to consider your spending and spot areas where you can cut costs. For example, you could save each year by switching your car insurance provider. You may also find you could save money on your supermarket shop to unlock more money in your budget.
3. Think about easy-access savings
When saving for your emergency fund, it could help to look for a savings account with easy access to your funds, so you can withdraw money quickly without losing any interest in an emergency, if you need to.
4. Maximise your savings efforts
With some banking apps, you can choose to round up your purchases to the nearest pound and automatically transfer the remaining funds into your savings account, so you don’t even need to think about saving.
The government’s Help to Save Scheme enables those who are on certain benefits to save and receive a bonus of 50p for every pound saved over four years. You can deposit between £1 and £50 every month. Tax-free bonuses are paid after year two of holding the savings account and again after year four.
5. Top up any savings that you use
It’s important to replace any money used from your emergency fund to ensure that you have enough to cover future expenses. Having a plan to top up your savings again will help make sure that you can cover any urgent financial situations that may arise.
How much should I save in an emergency fund?
Try to have at least three months’ worth of living expenses saved in your emergency fund. This should cover essential costs, such as rent or mortgage payments, household bills and food.
For example, if your monthly essential expenses come to £1,500 a month, your emergency fund should have at least £4,500.
The larger your emergency fund, the better position you’ll be in to cover larger financial shocks.
Although saving for an emergency can sound overwhelming at first, committing to setting money aside regularly will help you reach your ideal lump sum.
Should I pay off my debt before saving for my emergency fund?
Yes, it helps to prioritise paying off your debt first because there could be financial and legal consequences of failing to pay off debt and it may help you save money in the long run. This is because the interest paid on credit cards and loans is usually higher than any interest you can earn on a savings account. There are a couple of exceptions to this rule:
- Interest-free or low-interest debts:It may be possible to prioritise saving for an emergency fund if your debt is interest-free – a 0% interest credit card, for example – or lower than the interest rate on your savings account. But make sure that you repay the money you owe before the deal or loan term ends.
- Early repayment fees:If paying off your loan early would result in an early repayment fee, it may be better to prioritise saving into your emergency fund, rather than trying to clear it before your agreed repayment date.
Other ways of dealing with unexpected costs
There are several options to consider if you need help dealing with unexpected costs or loss of income:
- Accessing loans: You may be able to access funds by borrowing money from a bank, building society or credit union, through a credit card or personal loan to cover unexpected short-term costs. However, make sure you are clear about the loan or credit card terms and that you can afford to make the monthly repayments.
- Borrowing from family or friends:Where possible you may be able to borrow money from close friends and family to pay for unforeseen expenses. It’s important to have a written agreement and that you can afford the repayments before taking on the debt to avoid making your financial situation (or personal relationships) worse in the long term.
- Government support:If your income has been affected, you may qualify for benefit payments and tax credits to help cover your living expenses. A benefits calculator can help you find out what financial support you’re entitled to. If you are on certain benefits, you may also qualify for an interest-free budgeting loan to help you cover an essential cost. You may also be eligible for a hardship payment if you’ve applied for universal credit and you’re waiting for your first payment.
- Welfare assistance:You may be eligible for emergency assistance from your council’s local welfare assistance scheme if you are in financial difficulty. Each local authority has its own eligibility criteria and offers a range of support, including cash loans, food vouchers or free used furniture.
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