Emergency Funds: How to Prepare for the Unexpected

An emergency doesn't wait for a convenient time. A car repair, a medical bill, or a sudden drop in income could show up on any given day, often with little to no notice at all.

An emergency fund gives you a way to cover that sudden expense, without new debt. You don't need to have five figures stashed in the bank right away, though. Start small and stay consistent, and your emergency fund could grow into real protection for the surprises ahead.

What Is an Emergency Fund?

An emergency fund is money you set aside for unforeseen necessary expenses, or in case you lose income. Examples include reduced working hours, a mandatory home or car repair, or an ER visit. Without a rainy day fund, these could blow up your finances and derail your life, leading you to need debt relief.

Emergency funds are different from ordinary savings

• Your emergency fund must be easy to access and completely liquid. This means any asset that takes time to sell doesn't qualify. And don't use an account that requires you to request a check or wire transfer during business hours. A savings account that allows you to quickly transfer money to a checking account is your best bet to house your emergency fund.

• The money must be safe. Hold your emergency cash in an account that can't lose its value. It's not an investment; emergency savings is more like insurance. A high-yield savings account is a good choice (more on these below).

• An emergency fund shouldn't be subject to penalties. CDs with early withdrawal penalties or retirement accounts subject to tax surcharges don't make great emergency funds.

Emergency funds must be easy to get, and they should stay off your ordinary radar until you need them. Keep emergency money separate from all other accounts. And don't store your emergency account information on any shopping or bill-paying sites.

Why Is an Emergency Fund Important?

Suppose your beloved pet becomes seriously ill, or the car you need to get to work dies. If you don't have immediate access to cash, you may end up borrowing, and fast money tends to be very expensive (examples include payday and title loans, which charge astronomical interest rates). 

Once you borrow, it can be hard (or impossible) to quickly repay the loan on top of your other obligations. What begins as a small emergency can cascade into a much larger problem. Worse, the delay in finding money could cost you your job or even a pet's life. 

Without an emergency fund, you may feel more stress and lose sleep. Rainy-day cash could improve your financial, physical, and emotional well-being. It's a meaningful step toward a healthier financial future.

How Much Should You Keep in Your Emergency Fund?

To decide how much money you need for your emergency fund, you'll need to have a solid grasp on how much your household spending is every month. Ideally, an emergency fund comprises three to six months' worth of bills, to help you cover an unplanned expense or a few months without work (in case you lose your job). 

So, take a look at your budget (or create a budget if you haven't yet) and compare it to your actual spending to make sure your estimates are accurate. 

Your monthly spending likely includes costs that are wants, rather than needs—and there's nothing wrong with that, under normal circumstances. At the bare minimum, you should include your needs in your emergency fund, with the intention to pare back your spending should you find yourself out of a job. 

Needs should include:

• Food

• Shelter (your monthly rent or mortgage payment and associated costs)

• Utilities

• Transportation (car payment or public transportation costs)

• Insurance (auto, life, health, and pet, if you have this coverage)

• Child care costs

• Minimum payments on your debts

Once you have these essential costs in mind, multiply by three to get your ideal bare minimum emergency fund goal. For example, if your essential monthly costs add up to $2,000, multiply by three for a starter goal of $6,000, or by six for a fuller goal of $12,000. Then ask the questions in the next section to refine your goal.

Questions to ask to pinpoint your ideal emergency fund target

• What kinds of debt are you carrying? How much of your debt uses assets like your home or car as collateral (security)? You don't want to miss those payments or you risk losing those assets.

• How many breadwinners are there in your household? Can someone else cover the bills?

• How solid is your job, your employer, and your industry? How long would it take you to find a new job at the same salary level?

• Are you self-employed, salaried, or on commission? Does your income fluctuate?

• How well-insured are your assets? Do you have disability coverage? A home warranty? Life insurance? You could save money by buying less insurance. That trade-off is a bigger bill when something happens.

• How reliable is your friends and family network? Are there people who could help you get through a financial crisis?

Two salaried earners with low debt, job security, and good benefits can get away with a smaller emergency fund than a household with one minimally insured, self-employed earner in a risky line of work. If you haven't saved a large emergency fund, consider reducing your risk by upping your job security.

How to Build an Emergency Fund

The most important thing you can do with your emergency fund is to start it now, even if you can only save a few dollars each week. That's because every week you don't have an emergency is a week when you can grow your account and be a little safer than the week before.

Try these five S's to start an emergency fund from scratch:

• Sell. Get a jump on your emergency fund by selling unneeded possessions. Your favorite selling app or a neighborhood garage sale could turn them into cash.

• Sacrifice. Find at least one regular purchase you can give up until your emergency fund is full. Redirect what you normally spend for that purchase into your emergency account until you meet your goal.

• Slim down. Review your subscriptions and cancel everything you don't use regularly.

• Save extra cash. Put at least some of any windfall you receive, like a holiday bonus or tax refund, into your emergency fund.

• Set aside automatically. Set up an automatic transfer that moves part of your paycheck into an emergency savings account every pay period.

These are habits worth starting at any point in your financial journey. 

Best Accounts for Emergency Funds

Emergency funds shouldn't be held in retirement or investment accounts. Find an account that's easy to use, has low or no fees, and earns the best interest rate for its type.

The two main account types best suited for emergency funds are:

• High-yield savings accounts: These are usually offered by online-only banks, and since they don't have physical branch locations to maintain, they can afford to pay a higher interest rate on your money than you'll typically find at your neighborhood bank.

• Money market accounts: These accounts are like a hybrid between checking and savings. You can earn a higher interest rate (like a savings account) and get easier access to your money via checks or a debit card (like a checking account).

What Counts as an Emergency

Emergency funds work best when you reserve them for actual emergencies. A true emergency is a necessary, unplanned expense or a sudden loss of income. Common examples include:

• A job loss or a large cut in work hours

• An urgent medical or dental bill

• An essential home repair, like a broken furnace or a leaking roof

• A car repair you need to get to work

The key words here are both necessary and unplanned. A few expenses don't qualify as emergencies, even when they feel urgent:

• A vacation or a holiday gift

• A purchase you could plan, like a new phone or furniture

• A predictable cost, like annual car registration renewal or a new set of tires

Give those costs their own savings goal instead, so your emergency fund stays ready for a true surprise. Rebuild the account after you use it to keep your safety net in place for the next unexpected cost.

What if You Can't Save an Emergency Fund?

You may find it hard to save for emergencies when you're living paycheck to paycheck. Fortunately, there are other ways to backstop your wallet in an emergency.

One of the biggest problems with being unprepared for unexpected expenses is that fast cash is costly cash. (Remember, payday loans charge very high interest rates.) There are two ways to potentially minimize this issue:

1. Option one, set up a cash advance app. Free and low-fee apps could give you a short-term cash advance of up to several hundred dollars. Set them up before you need them. Explore options like Earnin, Chime, or Brigit.

2. Option two, apply for a credit card and reserve it for emergencies.

If you already have one or more active credit cards, you could reserve one strictly for emergencies. If they all have a balance, try the savings methods above to pay down your smallest debt as quickly as possible. That paid-off account becomes your emergency card. 

An alternative to credit cards is a personal line of credit. If you can put up something valuable as collateral or get help from a co-signer, you may have an easier time getting approved for one.

Again, the key to using credit for emergencies is to leave it alone unless you have an emergency.

Caught Off-Guard by an Emergency? Focus

An emergency you can't fully cover is a serious situation. Spend only on necessities until it passes.

Contact your creditors as soon as you can and ask about forbearance, which may allow you to pause payments or temporarily lower your payment amount. Cancel expenses you don't need to earn a living or stay alive. If the emergency is long-term, you may require professional help to manage, settle, or discharge your unsecured debt.

Concentrate on solving your immediate problem. Once the emergency has passed, work on preventing the next one.

Keep Your Emergency Fund on Track

Review your emergency fund balance every few months, especially after a raise, a move, or a change in your household size. Your target should grow along with your monthly expenses. At minimum, set a calendar reminder to check your balance twice a year, and adjust your automatic transfer amount if your income changes.

A milestone system could keep you motivated. Celebrate reaching $500, then $1,000, then your full three- to six-month goal. Small wins along the way often make it easier to stay consistent over the months it takes to build a complete emergency fund.