How to Create an Emergency Fund

December 18, 2020

An “emergency fund” is essentially a cash reserve set aside for unplanned expenses or financial emergencies. It’s your defense against Murphy’s Law, the idea that anything that can go wrong will go wrong over time, which could negatively impact your home, health, or finances.

While defining an emergency fund is relatively easy, determining how much money should go into your fund may not be. Should the fund be large enough to cover both minor and dire emergencies? After all, it’s far more expensive to cover the cost of a leaky roof than a leaky faucet, a dental implant than a garden-variety cavity, or a permanent job loss than a two-week furlough.

In fact, the safety net you require might call for two emergency funds — one for home emergencies, like a slab leak or massive termite infestation, and another for non-home emergencies, like a prolonged hospitalization or interruption in income. For example, by June 2020, as many as 7.7 million workers had lost jobs with employer-sponsored insurance because of the COVID-19 pandemic.1

The need for an emergency fund might not be so top of mind if current facts didn’t suggest otherwise. In a 2020 summer Bankrate survey, 21 percent of Americans said they had no emergency savings whatsoever. Moreover, 35 percent of Americans said they have fewer emergency savings now than before the coronavirus pandemic.2

Living on the financial edge can not only heighten stress, but also force you into some rash financial decisions, like resorting to high-interest alternatives, such as payday or title loans, which if not managed correctly could quickly entrap you in a revolving cycle of debt. Even putting a big bill on a credit card, then not paying it off in full, could cost you thousands of dollars in additional finance charges — money that could have built your emergency fund.

How much is enough?

You are going to encounter a multitude of answers and formulas to come up with a number on how much money you need for your emergency fund. One figure you hear a lot is to amass between three to six months’ worth of living expenses.

According to the U.S. Bureau of Labor Statistics (BLS) Consumer Expenditure Survey in the Ascent, a Motley Fool research report published Jan. 21, 2020, the average American household spends $5,102 every month.3 Therefore, if you wanted an emergency fund to cover your expenses (housing, health care, groceries, insurances, etc.)  for six months, you would need a cash reserve of $30,612 — for three months the total would be $15,306.

If you boast good medical insurance and healthy retirement accounts, your focus may be more on establishing a home maintenance emergency fund. One oft-quoted rule for a home maintenance fund says to set aside 1-3% of your home’s value. So, for a $360,000 house, this works out to $3,600 per year, or $300 per month.

Some financial experts advise setting aside 10% of your combined mortgage, property tax, and homeowners insurance payment each month. Given the median monthly cost of homeownership in the U.S was $1,556 per month, according to the most recent data from the Census Bureau’s 2018 American Community Survey, your monthly set aside for your home emergency fund would need to be $155.60.4

If you live in an older home, you may wish to increase your monthly contribution, regardless of what formula you choose to build your fund.

Jump Start Your Emergency Fund

One lesson of the pandemic is that the economy can shut down virtually overnight, meaning waiting until you have some extra money to build your emergency fund may not be an option. You must start now.

To jump start your fund, inventory what you own and see what you can sell. Look for things you wouldn’t miss or rarely use anymore. Maybe it’s vintage furniture, artwork, costume jewelry, tools, or an album collection.

If you receive a windfall or any sort of cash gift (tax refund, cash distribution from a class action suit, etc.), try to put at least a portion of this “found money” into your savings account to give your emergency fund a boost.

A freelance or part-time job could also raise extra cash. If you’re retired but want to work in some capacity to bring in extra cash, you won’t be alone. According to the Transamerica Center for Retirement Studies, 55% of American workers plan to continue working after retirement. Research cited by AARP’s Public Policy Institute shows that workers 65 and older are twice as likely to work part time as workers ages 25 to 64.5 Among AARP’s list of top 25 part-time jobs in 2020 were bookkeeper, school bus driver, office manager, receptionist, and merchandise displayer.

If working is not a possibility, don’t fret. Another way to build your emergency fund is to control your monthly spending. Then contribute a portion of what you save to your burgeoning safety net.

Once you start looking around, you can find potential savings everywhere, such as seasonally adjusting your thermostat, clipping coupons, and canceling unnecessary services or memberships.

For even more savings, try to get an interest-rate reduction on your credit cards if you carry a balance. Your task may be as easy as flipping over your credit card, calling the phone number you see, asking to speak to the manager, and requesting that your rate be reduced. If the credit card issuer isn’t willing to cooperate, suggest you’re going to transfer your balance to a competitor.

Customer acquisition costs can run into the hundreds of dollars, so you have more sway over your service providers than you think. Apply this same leverage by shopping around for better auto and home insurance rates.

More Options

Applaud your efforts to bring in more revenue and control spending to build your home emergency fund, but if you find these actions still fall short of the number you’re striving for, don’t panic. You still have many more rocks to turn over. Here are a few:

Check your homeowners policy to see exactly what it covers. Your home may have incurred damage covered by your homeowners insurance, such as rotted flooring caused by a burst pipe, missing roof tiles after a hail or windstorm, or smoke-caked walls in your laundry room blackened by an electrical fire in your clothes dryer.

Inquire about disaster relief. Due to the mounting number of natural disasters, increasing areas of the country have qualified as presidential-declared disaster areas, making it easier for residents in these afflicted areas who face uninsured or under-insured repairs to seek relief.

Seek local assistance. Many municipalities offer emergency repair loans and grants through HUD’s Community Development Block Grants (CDBG) program to qualified homeowners.

Consider FHA Title 1 loans. The Federal Housing Administration, which is part of HUD, offers Title 1 loans as a way for homeowners to finance property improvements and renovations, which make your home more livable. The maximum loan amount is $25,000 for improving a single-family home. You obtain the loan through an FHA-approved lender.

Still More Options

In lieu of an emergency fund for home, health, or other cash needs, you could, as a homeowner with good credit and equity in your home, apply for a home equity line of credit (HELOC). It’s a second mortgage that can be ideal for home improvements, as well as unexpected major expenses. Just keep in mind that the failure to repay your loan according to your contract terms could put you at risk of losing your home.

You could also take out a cash-out refinance, which would be a completely new mortgage with a new rate and new terms. You could use the lump sum you receive (the difference between your old loan and your new larger one) and use it for emergency repairs. Current low interest rates make this a favorable time for home equity loans, but again be mindful you’re putting up your home as collateral for the loan.

A reverse mortgage could add another arrow to your emergency fund quiver. This loan works differently from the two home equity alternatives mentioned above. First, it’s a loan for only those age 62 and older who enjoy sufficient equity in the home they own and live in as their primary residence. Second, unlike a cash-out or HELOC, you don’t have to repay the loan until you leave the home. You are still responsible, however, for the payment of property taxes and homeowners insurance along with the maintenance of your home. A reverse mortgage also offers the advantage of six different payouts after the loan pays off your current mortgage, if you still have one. One of these payouts is a line of credit for which you are charged interest only on the portion you use, again making it a great financial tool for either emergency or planned home repairs. Finally, whatever portion of the loan you don’t use continues to grow year after year, making it an outstanding reserve fund for whenever you need it.

Life is full of surprises. Your cellphone could fall into the toilet or lightning could strike your next-door neighbor’s tree, which falls on your property and punches a hole in your roof. You’ll be better able to deal with whatever life throws at you, knowing you have a safety net for emergencies, both big and small. So, start building yours today by any means possible, trying some of the tips and resources provided above.

We hope this article has given you some help with things to think about. Of course, every situation is different. This information is intended to be general and educational in nature, and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.

1 https://www.commonwealthfund.org/publications/issue-briefs/2020/oct/how-many-lost-jobs-employer-coverage-pandemic

2 https://www.bankrate.com/banking/savings/starting-an-emergency-fund/

3 https://www.fool.com/the-ascent/research/average-monthly-expenses/#:~:text=The%20average%20American’s%20monthly%20expenses%3A%20%245%2C102,a%201.9%25%20increase%20from%202017.

4 https://www.businessinsider.com/personal-finance/average-mortgage-payment

5 https://www.aarp.org/work/job-search/info-2020/part-time-jobs-for-retirees.html




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