Back to articlesWhat Is an Emergency Fund? Plus, Why You Need One
An emergency is pretty much any unexpected incident that needs to be dealt with right away. A broken-down car can be an expensive surprise. If you aren't prepared, an emergency can completely derail your household finances.
But about 37% of Americans didn't have enough savings to cover $400 worth of unexpected expenses, according to a Federal Reserve 2023 study.[1]
This article will cover what an emergency savings account is, what it's for, how to start one, how much to put in it and when to use it.
What is an emergency savings fund?
An emergency fund is a savings account you use to hold extra cash in case of unexpected expenses that can't be put off. Emergencies range from a broken-down car to a lost job or a personal injury. Unfortunately emergencies like these happen to people every day, which means a rainy day fund can be a real lifesaver if you find yourself in this situation.
What is the goal of an emergency fund?
The purpose of an emergency fund is to be able to pay for an unexpected expense without taking on new debt. The last thing you want is to be in a financial crisis after an emergency. Set aside some emergency money so you can always have financial security no matter what life throws at you.
Why do you need an emergency fund?
If you're one of the 78% of Americans living paycheck to paycheck, according to a Payroll.org study, an unexpected emergency could put you in the position of skipping groceries or even your rent.[2]
To avoid going hungry or risking losing their housing, some people turn to payday loans or borrow from credit cards at high interest rates. If you don't already have the money to pay them back, using a payday loan or even a credit card to cover an emergency puts your future financial stability at risk, costs you more money and makes it even harder to save money to avoid another financial emergency.
So do you need an emergency savings fund? Yes, you most likely do.
How much to save in an emergency fund
Everyone earns and spends different amounts of money, so you shouldn’t assume your emergency fund should be the same as anyone else’s. For most people, the best rule to follow is to keep a minimum of three to six months of expenses saved in an emergency fund.
The average US household spends about $72,967 per year, or $6,080 per month, according to 2022 Bureau of Labor Statistics data.[3] If you spend approximately $6,000 per month, you should have at least an $18,000 emergency fund if you have stable employment, or $30,000 (5 months of income) if you are self-employed or your income is more variable.
If a $18,000 emergency fund sounds impossible, don’t worry, start saving whatever you can. With the average car repair coming to to $548.32, according to Kelley Blue Book, consider making that your first milestone.[4]
Over time, you’d be surprised how much even small savings contributions can grow. For example, if you saved just $5 per week, you could have $240 by the end of the year.
It’s not $18,000 – but it’s a start and you can start to add to it over time.
Keep your emergency fund separate
If your emergency fund is mixed in with your other bank accounts, you may be tempted to spend the money on something else.
Remember, there’s a difference between saving for the purpose of buying something and saving money to use in case of emergency.
Keeping a separate emergency fund might also earn you more money in interest. Instead of your regular checking account, which could charge fees, consider moving your emergency fund to a high-yield savings account that pays you the most possible interest. Be aware that high-yield savings accounts often require a minimum initial deposit and a minimum balance to be kept in the account.
When to use your emergency savings
You should use your emergency fund to cover medical, housing or transportation-related emergencies. If you unexpectedly lose your job, you can also use your emergency fund to cover living expenses like utilities, groceries and rent or mortgage.
You shouldn’t use your emergency fund for “wants” like vacations, electronics and meals out. Instead, the cash should be kept only for true emergencies.
When to avoid using an emergency fund
If you have struggled with money in the past, your growing savings account balance could create temptation. When you earmark cash for an emergency, try to avoid gray areas that feel like an emergency but really are not.
For example, you may plan to use your emergency fund to pay for car repairs. But what do you do if your car breaks down and you decide it may be better to replace the car than fix it? If your car is broken down beyond repair and you need a car to get to work, then perhaps replacing your car is an emergency.
However, if spending a couple hundred dollars from your emergency fund could save you from wiping out your fund completely and allow you to postpone buying a new car, it might be better to just get the car fixed.
Where to keep an emergency fund
If you’ve decided to keep an emergency fund, you need a place to store it! Your current bank might be the most convenient, but it isn’t always the right choice.
Consider opening a new, online savings account at a bank which may have a high interest rate. Another option could be a money market account, depending on your goals and situation. For most people,though, a regular savings account works great as an emergency fund.
Using a savings account at an FDIC insured banking institution for your emergency fund ensures your money is protected and may earn the best interest rates possible. Keeping your emergency savings separate from your daily checking account also means you can't “accidentally” tap into your emergency fund account for other purposes.
When opening a new savings account, look out for an account that doesn't charge recurring fees and doesn’t require a minimum balance.
Bonus? If the account doesn’t require a minimum balance, you could start your savings with as little as a few dollars.
How to start a new emergency fund
If you’re running on a thin monthly budget, saving thousands of dollars might sound insurmountable. But don’t fret, you’ve got this. If you have enough cash to buy a few coffees each month or go out to see a movie, you can start an emergency fund.
If you can come up with just $5, $10 or $20 per month, you can set up an automatic recurring transfer from your checking account to your emergency savings account every month (do it weekly so you can see and feel the progress more quickly).
Set up an automatic transfer that matches your pay schedule and you won't even notice that you don't have the money to spend. It will just go into savings and you won’t have to worry.
For people who get paid by direct deposit, you may be able to split your direct deposit into two accounts. I used to do this to save for retirement and other goals. Contact your HR department to find out if this is an option for you.
Another option for kick-starting your emergency savings account is to use your tax refund for your first deposit. If you get extra money you weren’t expecting during the year (like a bonus, raise, part-time job, gift, etc.) you can put that money towards your emergency savings goal.
Why not just use a credit card to pay for emergencies instead?
Don’t have $400 in savings but have a credit card you can use to cover an emergency instead?
While it can be tempting to just charge an emergency on your credit card and pay it off over time, this approach means you add the cost of interest onto what could already be a costly expense.
If you’re not able to pay your card balance off immediately, and only pay the minimum amount due each month, you could be paying for that emergency for years to come.
According to the example below, if you have a credit card debt of $5,000 and only pay the minimum payment of 2%, you could end up paying more than $10,000 in interest over 30 years!
Source [5]
Having an emergency fund set up could help you limit or avoid extra interest charges and credit card debt.
Be prepared for the unexpected
Just like you need health insurance, car insurance and homeowner’s or renter’s insurance, you need a backup plan for surprise expenses or a loss of income. An emergency fund is to be used when unexpected expenses occur in order to give you some added financial stability. With an emergency fund standing by, you'll have a lot less to worry about. Start building your emergency fund today.
Sources
- Federal Reserve, “2023 Report: Economic Well-Being of U.S. Households” https://www.federalreserve.gov/publications/files/2023-report-economic-well-being-us-households-202405.pdf
- Forbes, “Living Paycheck to Paycheck Statistics 2024” https://www.forbes.com/advisor/banking/living-paycheck-to-paycheck-statistics-2024/
- BLS, “Consumer Expenditures Survey 2022” https://www.bls.gov/opub/reports/consumer-expenditures/2022/home.htm
- Kelly Blue Book, “Vehicle Repair Costs” https://www.kbb.com/car-advice/average-vehicle-repair-costs/
- TransUnion, “Paying the Balance vs Paying the Minimum” https://www.transunion.com/blog/debt-management/credit-card-101-paying-the-balance-vs-paying-the-minimum
About the author
Eric Rosenberg is the mastermind behind the Personal Profitability blog and podcast. He has both an undergraduate degree and a MBA in finance and his work has appeared in various media outlets. See Eric on Linkedin and Twitter.
About the reviewer
Lauren Bringle is an Accredited Financial Counselor®. Self is a financial technology company with a mission to help people build credit and savings.
Editorial policy
Our goal at Self is to provide readers with current and unbiased information on credit, financial health, and related topics. This content is based on research and other related articles from trusted sources. All content at Self is written by experienced contributors in the finance industry and reviewed by an accredited person(s).
