What Is an Emergency Fund and Why Do You Need One?

By Ashley Wirgau on May, 12 2022
Back to main Blog
Ashley Wirgau

The importance of an emergency fund cannot be overstated, especially for homeowners. Financial emergencies typically arise with little to no warning. Job loss, sudden illness, and large surprise expenditures can throw bank accounts for a loop. Even minor unplanned expenses may wreak havoc on those with limited savings, putting assets like cars or houses in potential jeopardy. So, how can homeowners protect themselves from losing it all should the unforeseen strike? Simple: build an emergency fund.


The Basics of an Emergency Fund


An emergency fund is precisely that – a fund to be used in the event of an emergency, any unplanned but necessary (and typically urgent) financial need. Emergency funds are separate accounts that holders maintain to protect themselves from financial hardship should trouble occur.


These “rainy day” accounts can range anywhere from a few hundred to several thousand dollars. Some holders even prefer to differentiate accounts into separate categories like "household emergency,” “loss of income,” or “medical expenses.” Those with grown children might choose to create emergency funds on behalf of their kids in order to assist their teenage or adult children should they face a financial crisis of their own. Whatever your individual circumstances, there is never a “wrong” reason to form an emergency fund, and anyone over the age of 18 could benefit from maintaining this type of savings account.


How to Start An Emergency Fund


As with anything, it is okay to start small. While an emergency fund of at least six months' income is desirable (a full year, if you have the discipline), it will likely take some time to compile that large of a cushion. Don’t let that discourage you, though. With a little planning and some willpower, you can be prepared for whatever economic hardships may lie in wait.


1. State Your Goals


Before you get too far, it is a good idea to sit down and figure out where you actually want to go. Bring your entire budget into view when determining how big your emergency fund should be. Do you have substantial monthly home, auto, or insurance payments? Have you already exhausted college loan deferments? Do you have assets to offload in case of financial duress? Are you solely reliant upon your own income or do you live in a dual-income household? Do you have children or adult family members who rely on you for all or part of their financial stability? All of these factors must be considered when determining how large of an emergency fund you require.


2. Schedule It Out


The absolute best way to build an emergency fund is to schedule direct deposits into a designated account. Do this weekly, monthly, or with every paycheck by setting your account to pull this money automatically. For those who receive commission or bonus checks, consider pre-determining a percentage of these payments to forward on to this fund. Don’t stress about the dollar amount either! It can be as little as $10-20 each time if that is all you have to set aside. This money will build and build rapidly if you truly earmark it for emergency use only.


3. Secure Your Savings


An emergency fund is to be used in serious situations, and as such, it should be stored in a serious location. Under the mattress just won’t cut it on this one. Invest the few minutes it takes to open a separate savings account at your local bank, credit union, or online provider. If possible, look for an option that does not charge annual fees, unless the benefit of an increased interest rate counteracts this expense. Nerdwallet recommends these 7 high-yield online savings account options for those hoping to have their money work for them.


4. Seek Out Unnecessary Expenditures


Should you encounter trouble finding excess cash to fund this account, it may be time to examine your current spending patterns. Comb through last month’s checking or credit card statement and highlight each non-essential purchase, or try a budgeting app to get a better picture of how those dollars are being spent. Then, challenge yourself to set lower limits for all bonus spending. For example, if “restaurants” equaled $200 last month, shoot for $150 and send the extra $50 over to that new emergency fund. If “entertainment” seems to be racking up hefty bills, consider dropping a streaming service. What other ongoing monthly fees could be eliminated in the interest of providing a bigger financial safety net?


5. Start Again


The hardest part of building an emergency fund is watching it get drained. Unfortunately, this is somewhat inevitable, especially for those who own a home. Even relatively new houses can present their fair share of problems. From late-night furnace issues to busted appliances to leaky roofs, homes can dissolve savings accounts faster than you’d realize.


Most emergent issues require prompt attention from the professionals, and professionals don’t come cheap. Unless you fancy yourself a jack-of-all-trades, expect to hit up that emergency fund from time to time when household issues hit. Then, once the bill is paid, pat yourself on the back for being so prepared and get ready to start all over again – because an emergency fund is no good if it’s empty.


If you are one of the many Americans without an emergency fund to fall back on, do yourself a tremendous favor and start one today. The only predictable thing about the future is its uncertainty, and only savvy emergency savers are prepared come rain or shine.