I am a big fan of Dave Ramsey, and as my husband and I pay down our debt, we follow a hybrid approach to his debt snowball method.
Followers of Dave Ramsey know that another part of his debt reduction plan is to create a budget and first save $1,000 in an emergency fund before beginning aggressive debt reduction.
Yet is this good advice for everyone?
Should some families have a larger emergency fund?
What is the right amount for your family to set aside in an emergency fund?
Peter has stated that while he and his wife paid off debt, they had a $2,000 emergency fund (which they have grown considerably now that they are debt free except the mortgage).
My husband and I cut it closer and only have a $500 emergency fund. As can be expected, this amount was too small, and we recently experienced a mini-financial crisis. For us, a $1,000 emergency fund is too small.
We have decided to initially create a $2,000 emergency fund with our tax refund and then to divert some money to increasing the emergency fund to $5,000 while still paying down debt.
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Considerations When Creating Your Emergency Fund
What is the best way to determine how much you should have in your emergency fund while reducing debt?
It ultimately depends on your own comfort level for risk and several other factors:
How much debt do you have to pay off?
If you have less than $8,000 to $10,000 in debt, chances are you can pay it off fairly quickly, so you may be able to get by with a smaller emergency fund.
If you have a much larger amount and know it may take you longer than a year to become debt free, you should probably set aside a large amount because emergencies over the course of several years are likely to occur.
How stable is your job?
In this economy, it sometimes feels like no job is truly stable and secure, but if you have a job with fluctuating income, you’ll need a larger emergency fund to see you through those periods of low income. I am a freelancer and make 1/2 to 2/3rds of our family’s income depending on my work for the month.
I have been a freelancer for 14 months and have been fortunate to see my work increase every month until last month when I lost several clients who lost their own source of income.
This was a wake up call that we need a cushion for those times when my income ebbs.
Do you own a home?
If you own a home, you will likely face unexpected repairs, sometimes costly ones. Is $1,000 in an emergency fund enough to cover a sudden roof repair if you want to avoid debt?
The answer is no.
While you wouldn’t need the entire amount set aside, you should have several thousand dollars set aside for unexpected housing repairs.
How old is your car?
A car that is only two or three years old is less likely to need expensive repairs than a car that is seven or more years old. If you have an older car, you need to have enough set aside for unexpected emergencies.
How many kids do you have?
The larger your family, typically the larger your expenses and the more you should have set aside.
We have 3 kids, and while they are healthy, unexpected expenses can still come up such as the three cavities the dentist recently said my son has.
Do you have insurance?
If you do, how good is your insurance?
If you don’t have insurance, the first thing you should do is get insurance because one accident or injury could lead you to bankruptcy. Even if you have to just have major medical or have to cover your children through state funded care, insurance is essential.
However, many people do have insurance, but the coverage is poor. How much do you have to pay annually out of pocket? What is your maximum deductible? All of these answers will help you determine how big your emergency fund has to be.
Emergency Fund Size Is Subjective. Choose The Best Size For You
How much to save in an emergency fund when paying down debt is a personal decision.
We have taken risks with a very low emergency fund of $500, and we were caught off guard when several reimbursements were very slow in coming, resulting in a significant budget shortfall.
That situation combined with my income actually decreasing for a month led us to the decision to increase our emergency fund.
This might not be the right strategy for everyone. Use the list above to determine how likely you are to face an emergency and how much money you should set aside.
How much do you have saved in your emergency fund? Do you feel like it’s enough?
We found that the $1000 emergency fund just wasn’t enough at our house as we had an older car, and a history of health problems for my wife. We saved up the $2000 emergency fund as you mentioned because we figured that would cover most emergencies.
Our deductible for our health insurance was about $2000, so we knew it would cover even a major health event. My wife ended up going to the hospital while we were still paying off debt, but because we had the slightly larger $2000 fund we were able to pay all the hospital bills (about $1800) without going into further debt. Of course after we paid that, we had to re-fund that account.
I think it truly is a personal family decision, one that you need to sit down and figure out what your risks are, how likely they are to happen, and what coverage you have in case of accident, health problems, etc. For us, a $2000 emergency fund was perfect. Others may not need as much – or might need a little more.
Those are all extremely important things to consider.
I’m a Dave Ramsey fan too but any time a person makes a blanket statement isn’t wise. Everything is ALWAYS fact dependent.
We never felt comfortable with $1000 considering we owned and home and knowing it was going to take years to pay off our debts. We’ve settled on a $3,000 emergency fund but we have (what most people classify as) “savings” for other things such as car replacement on top of the E-Fund.
Depending on the scenario, I use a range for my clients of $500-$5,000.
I like having $1,000 emergency fund for house stuff, cars, plane tickets, whatever.
I’m still working on building my own emergency fund, and this has enlightened me on a few things I need to keep in mind. For me being on my own, I think I can keep my fund relatively low and still be OK. Might be coming up on some car maintenance bills pretty soon, though.
To me, the point of having an emergency fund isn’t to make you comfortable. It’s suppose to still feel like “Oh crap, I wish I had more money saved up” to help motivate you to pay off debt.
For a lot of people, while it would be safer to have a $2000+ emergency fund, they’d spend months and months trying to build that up and lose motivation to even start the debt pay off process and end up giving up.
I’m a proponent of doing what Dave Ramsey talks about in his program, getting intense for a short time in order to build up your emergency fund – including selling things you don’t need and even taking on part time jobs. You could even continue doing that while you’re getting out of debt. Not long term necessarily or you could burn out, but for a period in order to pay off debt. So for you, it sounds like a $1000 emergency fund would be enough because you need that extra boost to motivate you. For us, we knew what our level of risk was of certain things happening and us going further into debt, and we saved up accordingly.
I agree completely with evaluating your actual risks over the length of time it might take to pay off debt. It doesn’t help to go backwards with a small emergency fund that runs out too quickly. In the case of job or income loss, perhaps estimate how long you would be out of work, the amount of $ loss & how likely during the debt payoff period. So if you earn $2,000 per month, could be out of work for 4 months before finding something else, and the likelihood is about 30%, then $2,000*4*.3= $2,400. For unexpected expenses, try the same idea – old car is likely 80% to need $1200 repair during time period, then $1200 x .8 = $960. Total potential emergency during time period = $960 + $2,400 = $3,360, or 1.68 months of income. ($3,360 / 2000). Even if you decide to use a different number for your emergency fund, the process will make you think thru what things could go wrong & how likely are they to happen. Which is a good exercise. I would concentrate on the bigger risks and not worry too much about lots of smaller things. It’s the big, likely to happen things that will kill an emergency fund.