Years ago, while driving home from college, my car broke down at a toll booth. I naturally panicked. Not so much from the embarrassment — but the dread of how much this was going to cost me to tow and repair.
Most of us don’t like to spend money on such matters. It’s even worse, though, when you don’t have the money in the bank to take care of such an unexpected surprise. From that point on, I made sure to have an emergency fund on standby.
As the name implies, this is simply a savings account that you only use when you have to pay for a large, unexpected expense. Ideally, you should have saved to cover 3-6 months of essential expenses. To start, however, have a minimum of $1,000 saved so that you don’t put yourself into massive debt.
What is Considered a Financial Emergency?
But, what exactly constitutes a financial emergency? Well, purchasing a shiny new iPhone or taking off to the Caribbean does not count. Rather, it would be the following seven examples.
1. Dried up cash flow.
Without question, losing your primary source of income is a financial emergency. In fact, it’s probably the main reason why you should stash away an emergency fund. Even worse, sometimes, this can seemingly come out of nowhere.
Regardless if you’re a freelancer who lost a client or recently received a two-weeks notice, this can have immediate consequences, including:
- The most obvious fallout is that you no longer have a source of income. In addition to causing stress, this means you can no longer pay your expenses, which could result in damaging your credit score to having utilities shut-off. If you used credit cards to stay afloat, that will bury you in debt. Even if you can receive a severance package or unemployment, that will still only be a percentage of your previous salary.
- Did you receive benefits like health insurance or retirement contributions from your previous employer? If so, and you’ve lost your position, then you may have to stop funding your plan for the time being or pay out-of-pocket medical costs.
- It may take several months for you to find a job that was comparable in pay to your former salary. If you don’t have anything set aside, you’ll continue to struggle to keep up with your expenses.
- Physical and emotional health will also suffer as you may experience feelings of failure and hopelessness. In turn, this causes financial stress, a strain on your relationships, and engaging in unhealthy habits like a poor diet or substance abuse.
2. Medical or dental emergencies.
Even if you are fortunate enough to keep your primary source of income, you know when you’ll have to deal with a medical or dental emergency. For example, you may have to be hospitalized due to a sudden illness or accident. And, that visit to the ER can be as much as a mortgage payment or car note.
What if you have insurance? It’s still possible that you’ll be responsible for a co-pay, which is on average $250. “However, with the advent of high-deductible health plans in recent years, even insured persons may have to foot the entire bill if they have not met the plan’s annual deductible,” explains Janet Hunt over at The Balance.
“These deductibles must meet the IRS 2020 minimum’s of $1,400 for an individual, or $2,800 for a family to be considered an HDHP,” adds Hill. “The deductible could be even higher depending on your plan.”
And, things can be even more concerning if you’re a pet owner. An emergency visit to your veterinarian can range between $250 to $8,000!
3. Home/car maintenance and repairs.
“Homebuyers rarely consider how much it will cost to own, operate and maintain a house,” says Ilyce Glink, author of “100 Questions Every First-Time Home Buyer Should Ask” and publisher of ThinkGlink.com, told Discover. “They’re very interested in looking at how much mortgage, taxes and insurance will cost. If a homebuyer is on the edge of affordability, buying a bigger house with higher maintenance and upkeep could push him or her over the edge financially.”
Want to avoid such a scenario? Then you need to have an emergency fund to not only keep your home safe and in good order, but also unforeseen expenses.
Other examples could be a natural disaster damaging your home or a pipe bursting in your bathroom.
How much should you have saved for home repairs? “According to the one percent rule, you should set aside at least one percent of your home’s value every year for home maintenance,” recommends the Discover team. “For a $360,000 house, this works out to $3,600 per year or $300 per month.”
How do you determine how much emergency savings you need on hand?
Another good rule of thumb is “saving 10 percent of the total cost of your property taxes, mortgage, and insurance payments,” Glink says. “This is probably the minimum amount you should plan for.”
If you own a vehicle, the same concept needs to be applied. In addition to keeping your vehicle in tiptop shape, you want to be able to pay for any potential swift expenses. AAA suggests setting aside at least $50 a month for routine maintenance and repairs.
4. Unanticipated travel.
What if a loved one suddenly becomes sick or ill? You probably don’t have enough time to compare travel or lodging expenses. You also don’t have the luxury of waiting until you spot a better deal.
Instead, you probably have a last-minute plane ticket at an exorbitant price because you have no other choice. Even if you found an amazing deal, it’s still a cost that you haven’t accounted for.
What’s unanticipated travel?
Additionally, you may be forced to extend your travel due to factors that are out of your control. For instance, a snowstorm or 24-hour bug could force you to book your lodging arrangements for another day or two. You may also have to purchase a new plane ticket.
One of my friends had to deal with this same type of scenario while attending a wedding. They couldn’t make their flight, which required them to book another night at their hotel and then book a new flight. They didn’t have the funds for these extra expenditures, and he had to borrow the money from his parents.
5. Bigger-than-expected tax bill.
The last person you would want to be in debt to — would be google old Uncle Sam. But, this debt can occasionally happen. In fact, plenty of Americans who received a refund the previous year were shocked to learn the following year that you owe the government money.
In 2019, this was common for some people like Andy Kraft and Amy Elias of Portland, Oregon. The couple was used to getting a small refund. But, in 2019, they owed $10,160.
“I will never forget the moment; I thought, ‘We look good,’ and then we added in the next W-2 and my jaw hit the floor,” Kraft told CNBC. “There was no way I wanted to believe that what I was looking at was accurate.”
Before you have a panic attack, realize that there are ways to handle unexpected tax bills. For starters, file on time and pay what you can to avoid fees and penalties. You may also be able to request an extension or set up a payment plan.
If those aren’t options, then you can tap into your emergency savings. By using your emergency savings, you don’t have to take out a loan or borrow money from family, friends, or even your 401(k).
6. Sudden moves.
Several years ago, during the middle of a brutally frigid winter, the heater in my home went kaput. Unfortunately, it was going to take a couple of days to repair. There was no way I could stay at my place, so I had to check into a hotel room for a couple of days.
For me, this was a double whammy. In addition to the $800 repair pair, I was also out $300 for the hotel. Luckily, I had enough savings for the heater. But, I didn’t have money for the hotel and I had to, begrudgingly, use my credit card.
Another example of a sudden expense would be if your company is relocating to a new building or accepting a new position in a new state. While not as last-minute as my heater experience, this could happen faster than you can save to cover any moving expenses.
Your employer may cover some of these expenses. But, don’t bank on them to pay for everything.
7. Funeral costs.
While certainly a grime topic, we also know it’s inevitable. What’s more, funerals can range anywhere from $1,500 and $15,000. I recall when a friend lost her father and was shocked at how expensive the funeral was and how her family scrambled to pay for it.
What if they had life insurance? You will get reimbursed. But, that could be months before that happens.
The bottom line.
Building an emergency fund ensures that you’re prepared for anything that life throws your way. Best of all, it doesn’t take much to get started. If you put aside $100 a month, you would have $1,200 within a year — and that could make all the difference in the world to your budget.
Even more — you’ll feel so much safer and it will make all the difference in your mental health.
If you must withdraw from your emergency fund, make sure that you replenish it as soon as possible.
