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Do you really need an emergency fund?

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Saving for a rainy day means you can cover unexpected costs without getting into debt. Here is how to save and how to cover emergency costs if you don’t have money put aside.

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Life is unpredictable and you never know when a boiler will break down, your car will stop working, or you’ll lose your job. Having some money set aside, in an account that pays interest, means you can dip into this when emergencies happen. This avoids you having to take out credit, which can be expensive, and gives you a buffer before you need to start eating into your regular savings.

What is an emergency fund?

Saving up for a rainy day means putting money aside that you can dip into if you need cash in an emergency. It could cover expenses like:

  • Car repairs

  • House repairs

  • An unexpected medical bill, e.g. emergency dental treatment

  • Paying for basics if you lose your job

  • Paying your bills if you are unable to work for health reasons

Do you need one?

If you can afford to save a little a month and would not be able to afford the above costs from your wages, it's worth saving an emergency fund.

It’s also worth considering the following points: 

  • More urgent costs - like expensive debts - should be prioritised 

  • You may have insurance policies that cover emergencies

How much should you save?

An emergency fund should be enough to pay all your most important bills for several months.

Three to six months of your usual wages or income is a good amount to aim for, although anything you can put away will help.

The exact amount you need depends on your circumstances; for example, you may need more if your partner or children rely on your income.

What else should you save for?

You could also have a separate account if you are saving up for a mortgage deposit or for luxuries like a new car or a holiday.

How to save

The best way to build up an emergency fund is by saving money every time you are paid, e.g. monthly.

The easiest way is by setting up a standing order for a certain amount or a sweeping service. This can move any money you have left at the end of the month from your current account to your savings. However, this is only worth doing if you’re disciplined enough not to spend it all.

Keep it in a separate account

Keep your savings separate from your main current account so you can:

  • Keep track of how much you have saved up

  • Make sure you do not accidentally spend your savings

  • Earn interest to boost your balance

Choosing an account with a high-interest rate means your savings grow quicker, but fixed-rate bonds are usually unsuitable. They often don't let you withdraw until the end of the fixed term, even if you need the money in an emergency.

An instant-access savings account lets you withdraw some or all of your money whenever you need it without fees or interest penalties.

You could earn more interest by opening:

  • A regular savings account, which pays interest if you pay in each month

  • A cash ISA, which is a type of tax-free savings account

How to choose the right type of savings account

Pay in extra when you can

As well as paying in regularly, you can boost your savings if you get extra money from something unexpected such as:

  • A raise or bonus at work

  • Paying off a loan or credit card, leaving you with more money available each month

  • A tax refund

  • An inheritance or another financial gift

You could pay this extra money into your savings to build up your emergency fund quicker.

Alternatives to saving

Having an emergency fund is important and it can save you a lot of stress and financial problems when unforeseen events do occur. However, it’s always worth considering all of your options.

Pay off your debts instead of saving

The interest you pay on your loan, credit card or mortgage is likely to be much higher than the interest you can get on a savings account.

This means paying off your debts could save you more money than a savings account could make you in interest. But raiding your savings could leave you short of money in an emergency. It might be worth paying off your debts from longer-term savings, such as for holidays or other luxuries, but keeping your emergency savings in a different account.

Here is how to decide if you should pay off your debts with your savings.

Cover your costs with insurance

You can pay for some emergency bills with an insurance policy if you have one in place instead of saving up to pay them yourself. You can cover:

  • Health problems with critical illness cover, which can cover your bills if you are too ill or injured to work, or health insurance, which can pay your private medical bills

  • Losing your job with income protection insurance, which can cover your bills if you become unemployed or are unable to work

  • Expensive property bills with home insurance, which can cover your possessions or your property

  • Car repair bills with car insurance, which could pay out for damage caused by accidents, theft or vandalism

Insurance policies can make covering a large cost more manageable. But you do not get the money you pay for the policy back if you do not need to claim. Instead putting the same amount of money you would pay an insurer into a savings account means you have the money, should you need to use it, but if you don’t you can use it to put towards other costs. 

Other ways to cover unexpected costs

If you do not have enough money to pay a bill you could also use a:

However, these options can all be expensive. There are ways to cut costs, if you can, such as by using an interest-free overdraft or a credit card with a 0% deal on purchases that could let you borrow for free, as long as you pay it back in time. If you aren’t able to pay the money back, you’ll start paying interest which makes these options more expensive than using your savings.

If you get a loan, here is how to work out the cheapest way for you to borrow money.

Help stretch your budget a little further by making the most of your savings.

About Dan Base

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