This article is the fifth in a series on how to get out of debt. If you haven’t already, you should check out the previous articles:
- Step 1 – Declare War on Your Debt
- Step 2 – Stop Increasing Your Debt
- Step 3 – Create a Budget & Stick to It
- Step 4 – Find Ways to Cut Back & Earn More
Step 5 – Build a Starter Emergency Fund
By now you should have created a budget and found ways to cut back and earn more. But before you start putting that extra money toward your debt, you need to make sure you have a basic emergency fund in place. I’m not talking about having six months of living expenses saved up. You need enough to cover basic emergencies while you work on getting out of debt.
First, realize that you need an emergency fund. If you have an unexpected expense of $1,000 today, where would you get the money? If borrowing is your answer, consider how much that will set you back on your goal to get out of debt. An emergency fund will help you get out of debt faster because you won’t have to keep increasing your total debt every time an emergency pops up.
Next, decide where you’ll keep the money. Inflation will eat away at your emergency fund if you keep it under your mattress or at your local big name bank. Instead, consider a credit union or high-yield online savings account where you’ll get a higher interest rate. I prefer ING Direct and explain why in my article Where to Keep Your Emergency Fund.
Finally, set a goal for your starter emergency fund. I recommend at least one month’s worth of living expenses to begin. Dave Ramsey says $1,000 and others have upped it to $2,000. But how much your emergency fund should be depends on your personal situation. In fact, a starter emergency fund with one month’s worth of living expenses may not be enough if your income is unstable or you (or your family) are accident-prone. Instead, you might want to shoot for two or three month’s worth to start.
Once you have your starter emergency fund established, we’ll go after tackling your debts. Then you can complete your emergency fund depending on your needs. Paying off your debts without having savings in place is quite foolish, so make sure you don’t skip this step!
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Have you built up your starter emergency fund yet? Let me know in the comments below!