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An emergency fund helps you avoid major financial problems if you experience a loss of income or illness. Read on for three disasters it could save you from.
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Having an emergency fund in a high-yield savings account shouldn’t be viewed as optional.
While it may be difficult to save up cash for unexpected expenses, you need to prioritize doing so in order to reduce the risk of a long-term financial disaster resulting from a bump in the road.
Here are three ways that having three to six months of living expenses saved could help avoid a long-term crisis that affects you for years.
1. It could allow you to keep paying your mortgage to avoid foreclosure
If you experience a serious bump in the road, like a job loss or an illness, you could be left unable to pay your housing bills. And, this could be devastating. The National Bureau of Economic Research revealed that 94% of mortgage foreclosures occur as a result of negative life events such as unemployment, divorce, or medical issues.
If you’re foreclosed on, you’ll lose a lot of the equity in your house. Your credit will be severely damaged so it may be difficult to borrow again or find a landlord willing to rent to you. It could take you years to get back to the same position.
An emergency fund allows you to avoid this by enabling you to keep making payments on your home either until you get back on your feet or until you have time to sell it for enough to pay off your mortgage and hopefully walk away with some profit.
2. It could help you ensure your car doesn’t get repossessed
Many borrowers have to stretch to afford a car, and many take on expensive car loans with long repayment terms. In fact, at the start of 2023, a record number of consumers (15.7%) committed to monthly costs of $1,000 or more for their auto loans, according to data from Edmunds.
If you have unexpected expenses, a job loss, or other issues that persist for a few months, you may find yourself unable to face these payments. This could lead to vehicle repossession. This will also damage your credit score, plus it will leave you without a car you may need to get to work.
If your car is repossessed and the lender doesn’t get all their money back from reselling it — a common outcome, since many cars are worth less than what you owe — you could also find yourself stuck making ongoing payments on a car you no longer own.
If you have an emergency fund, you can keep making your car payments even when your income takes a hit. This could give you the chance to keep the vehicle. Or, if you won’t be in a position to start making payments again, your emergency fund could enable you to sell the car while repaying any remaining balance of your loan if your car isn’t worth what you owe.
3. It can save you from getting trapped in a debt cycle
Finally, an emergency fund can keep you from becoming trapped in a cycle of debt that lasts for years to come.
Say, for example, you’re living paycheck to paycheck with no money in the bank, no extra funds, and you have a $1,000 emergency. If you have to borrow for that $1,000 on a credit card at 20%, you’d have a minimum payment of around $27. That would mean, even if you paid the minimum, you’d now be $27 further behind every month. You’d either have to cut back or borrow an extra $27 a month each month to maintain your current spending levels.
And, if you did that and just paid the minimums, it would take you 117 months to become debt-free, and you’d pay an extra $1,056.74 in interest — more than the cost of your initial emergency.
If you have multiple emergencies over that 117 months, you could keep adding to that balance, resulting in a higher monthly payment, a bigger shortfall, and even more challenges making ends meet. Or, if you wanted to pay extra on your debt, it would be even harder to pay the bills each month.
You don’t want to face any of these outcomes. So, start working on saving for emergencies right now. Open a high-yield savings account and find just $10 to transfer into it — perhaps by bringing lunch to work instead of buying tomorrow or using some coupons and shopping the sales flier on your next trip to the grocery store.
Then, keep working on adding to that emergency fund a little at a time or whenever you get extra money such as a tax refund or a bonus at work, extra money from a side gig, or birthday money. Even a small emergency fund is better than nothing and, if you are diligent about finding extra cash to put into it each month, it will eventually grow to provide the protection against disaster that you deserve.
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