Trying to work your way out of debt, and wondering if you should save some money for an emergency fund before you pay down your debt? Wondering how much money you should let just sit in your savings account, doing nothing, while you try to get rid of your debt?
Dave Ramsey recommends $1000 for your emergency fund. I think that’s fine if you have credit card debt, but I think it’s low once you move onto lower interest debt reduction, such as car payments and student loans. I have kept $5000 in my emergency fund for years now, and we recently had the perfect storm to wipe it all out. Luckily, we should have it filled back up just within a couple months, but here’s what happened to us (something similar could happen to you, so read on).
A little over a month ago, I took a position at a new company. I wasn’t looking to leave, but this new job seemed like a perfect fit for me (it’s been awesome so far, so well worth it). At the time, my wife was 7 months pregnant, so switching insurance could be a pain. Also, the cost of having a baby with the new insurance is $4000-$6000 more than my old insurance, plus they have a waiting period before your even eligible.
It turns out I wasn’t eligible for the new insurance until after the baby is born, which means I have to pay the COBRA fee to keep my old insurance for two months (at roughly $1500/mo!). I took that into consideration before I accepted the position, and figured I could just take the $3000 or so out of our emergency fund to cover the difference. Right there is benefit #1 of having a larger emergency fund. I wouldn’t have been able to accept this new position if I didn’t have an emergency fund in place.
We moved into a new house 2 and a half years ago, and we just got hit with the tax increase. I’ve been saving up for it for a few months now, and had most of it saved. But I was still just over $1000 short. Of course, they sent me the bill at the same time as me accepting the new position. I could either pay the tax that’s due right now, or let it average out over the next year in my escrow account. Of course, if I average it out, they’ll charge me a $60/mo convenience fee. Of course I paid the full amount. $4000+ of the emergency fund wiped out.
The dishwasher in our rental property went out right before all this happened as well. That dishwasher was a Maytag, and was only 2.5 years old. It would have costed me around $200 to get it fixed (the front panel went out), and it only costed $350 new. The dishwasher that came with our house was construction grade, so it would be better served in a rental property than our home, so we decided to get a new one for our house and move ours to the rental. I’ve got a separate account set up for the rental property, but I transfered $300 over from our personal account to split the cost between the two accounts.
And of course, our deep freezer quit working this past weekend. I got it off Craigslist about 4 years ago for $150. It’s probably 20 years old, but it kept the food cold. I monitored the cost of electricity to run it, and it averages around $20/mo to keep food cold. I thought that was high, but we used it all the time so it was worth it. When it went out, I figured it would cost us $75-$100 for someone just to look at it. I figured it would probably be better to just replace it. I looked on Craigslist again, and found some for $150-$200 that would fit our needs. But I went to look at new ones, and found one for $440. The new one costs $35 per year (not month) to run! So we decided to get a new one, and figure the savings in electricity would outweigh the cost of the unit in just 2-3 years. Emergency fund completely wiped out!
If I didn’t have a larger emergency fund saved up, we wouldn’t have been able to handle the perfect storm that happened over the past month and a half. We would have gotten a cheap deep freezer as a replacement that would cost us more to run over the long haul than a new one, and we would probably be fighting a whole lot during this process. Instead, we just wiped out our emergency fund, and should have it replaced in just a couple of months due to some extra income we have coming in (claiming our flex pay spending for daycare for one), so it wasn’t stressful at all. In fact, we made the last payment on my wife’s car during this process, which was double the normal monthly payment. So we wiped out a debt in the middle of this perfect storm that could have easily done us in financially. I got a better job, our property taxes are up to date, and we replaced two failed appliances at the same time, all because we had the emergency fund in place to handle the situation.
My recommendation to you is to save $1000 in your emergency fund if you still have credit card debt, but increase it to $5000 once you get your credit cards paid off. It’ll most likely come in handy at some point in the future.