In my first “How Do You Get Out of Debt?” post, you learned that if you want to completely get out of debt, the first things you have to do are to get mad, get naked, and make a budget. So what do you do next after you find yourself sitting mad and naked at the kitchen table with budgeting forms and a calculator? You start the next step to getting out of debt, of course! I'm talking about a $1,000 emergency fund.
$1,000 Cash on Hand for an Emergency
The next step that will propel your naked self toward debt freedom is putting together a small emergency fund of $1,000.
That's right, in order to get out of debt, you need $1,000 cash on hand.
However, if you have a low income, say $20,000 or less, you can do $500. If you have a high income, say $100,000 or more, then $1,500 would be sufficient.
I can hear you now, “Seriously Doc? I'm living paycheck to paycheck, I'm deep in debt, and you want me to come up with $1,000 cash, just to let it sit in a bank account in case I need it?”
Yep, that's exactly what I'm sayin'.
Your next question would likely be “Why? If I come up with $1,000, shouldn't I just use that to pay off my debt?”
No. And I'll tell you why below…
Having a Starter Emergency Fund Boils Down to One Word: INSURANCE.
Your small emergency fund acts as insurance against all the inevitable small to medium sized financial emergencies that spring up out of nowhere and ruin your day.
You know what I'm talking about. Like when the washing machine or the water heater dies, or the roof springs a leak.
They ARE going to happen. You know they are going to happen. They always do sooner or later.
Remember, at this point in the process, you've gone “naked” when it comes to using credit. You've sworn off taking on any more debt. And that means you have to be prepared for what you know will inevitably happen.
Your $1,000 emergency fund allows you to be prepared to pay cash when the inevitable crisis happens. You won't be tempted to to use credit cards or “easy payment” plans that keep you in bondage for months or years while you pay off an emergency expense.
Creating a beginner emergency fund also helps change your mindset about how to deal with the unexpected. When you don't have a plan (like most people), you end up deeper in debt (like most people).
But when you become proactive and have money set aside in cash or a bank account specifically for an emergency, you simply pay cash to clean up the problem and move on. The result is that you have less stress and you're not dealing with that emergency 6 months or a year from now because you're still paying for it.
You are self reliant and self insured. No longer will you have to call upon Chase or Discover to bail you out!
Getting a $1,000 Emergency Fund Together is Not as Hard as You Think
I know, I know. You're in debt and you're struggling. It's hard to come up with $1,000.
But you CAN do it. Anybody can do it. You may just have to get a little creative, that's all.
Maybe you can pick up a few extra hours at work. Or sell all the junk you don't use and don't need in a yard sale or on EBay. Cut some yards, clean some houses, babysit, bake cookies, or use any job skills you may have like accounting, bookkeeping, or computer skills.
There is always a way! (Find out lots more ways here)
Budgeting Helps Build Your Fund
By the way, if you're following the plan I've put forth in this series of posts, you've already started doing a written budget. My experience is that when you started doing a written budget, you pay more attention to what you're spending.
Inevitably you find at least a couple hundred dollars every month you didn't know you had. You can use that to help build a small emergency fund as well.
Just What is an Emergency?
Once you get your starter emergency fund together, you should really think about what defines a real emergency.
An emergency is NOT a broken iPad, a busted TV, or the fact that the cute pair of shoes you've been craving just got marked down by 50%. An emergency is not a scope for your hunting rifle because deer season starts next week. It's not a new game system because your old one finally died.
A real emergency happens when little Johnny breaks his arm, or you have no hot water, the basement flooded, or the roof is leaking.
It's not used to purchase something you failed make allowance for in your budget.
While you're trying to get out of debt, $1,000 dollars will cover most run of the mill emergencies.
Later in the series, I'll show you how to build a 3-6 month emergency fund. Then you'll have protection against a major crisis such as a job loss, health emergency, natural disaster, etc.
What if I Have to Use My Emergency Fund?
If you have an emergency while you are getting out of debt and you have to dip into the funds, your first priority should be to pay back your emergency fund ASAP.
If you're in the process of paying off debt, then pay only the minimum payments on your debts until your emergency fund is replenished. That way, you continue to be self insured and you'll remain confident that a typical emergency will be easily taken care of.
What's the Point of an Emergency Fund?
The point of all of this is that you want to be proactive to eliminate any problems that will derail you from getting out of debt and achieving financial freedom.
When you have a solid plan in place, and $1,000 in cash set aside for those typical emergencies that WILL come, you won't have to resort to using credit cards like so many people do when they have no plan.
So remember: Stay mad, stay naked and keep reading these posts! When you follow the steps outlined here, you WILL become debt free!
And don't forget to bring your friends along for the ride.
In the next post I'll show you the next step in the process that will allow you to pay off your debt faster than you ever thought you could!
Question: Did you ever have an emergency that put you in a bind financially because you weren't prepared? Leave a comment and tell me about it.