Elizabeth Kerr talks emergency funds, and why your credit cards and mortgages don’t count

Short headline: 
Your emergency is not my problem!

By Elizabeth Kerr

Sometimes things happen that take our lives by surprise and leave us completely dumbfounded and exhausted.

A sudden passing of a loved one, getting fired, the love of your life decides they need to “find themselves”, or a “car just pulled out from nowhere”.

Regardless of what it is, you are left holding the proverbial can, and need to figure out how to get back to the new normal as quickly as possible.

For some "life-lemons", having insurance will be a God-send. But insurances don’t cover surprise babies, wayward lovers or losing your keys – and they usually have a stand-down period whereby you have to support yourself until the money is paid out.

For that time and every other life disaster you need an EMERGENCY FUND!

What constitutes a financial emergency?

There are two categories an emergency fits into:

  • An unexpected expense, whereby, for example, something happens and you need to spend money to get through it. Examples of this could be a rescheduled flight to get home in a hurry, or seeing a dentist, or a car needs a new battery. You get the idea.  
  • A loss of income emergency – for example, being fired, taking a pay cut, or having your hours/overtime reduced.

How much do I need?

You need enough money to meet your non-negotiable expenses for three months – shelter, food, insurance, basic transport and one communication device.

Obviously, if you are without income you won't be taking holidays, updating your wardrobe or treating yourself to lunch out every day, so, there is no real point in having any extra money over and above your non-negotiable needs set aside.

Your emergency money can form the base of your money machine.

If you’ve been living payday to payday and consuming on a whim, then putting money aside for no realised reason is probably a challenge.

If you are starting from $0 then your first goal is to get to $2000 – ASAP!!! This needs to be done with the same energy you would employ if your pants were on fire.

We will call this your emergency kick-starter.

The sum of $2000 will cover most short-term emergencies such as accommodation or flight changes, basic car repairs, a few days off work, or paying your rent and the like. The rest of your emergency fund can be made in regular deposits over 3-12 months after the initial $2000 is saved.

Build an emergency fund, or pay off debt?

That is a good question.

The answer is a bit ‘chicken and egg’ and it depends on the types of debts you have. If you lose your job, your debts are still going to need to be paid. You will need to have enough money set aside to sustain these debts as well.   However, if you pay your debts off then you won't need as much emergency money.

My suggestion is that if you have consumer debt such as credit cards, personal loans, payday loans, overdrafts, or store loans, then save your $2000 ‘Kick-Starter Emergency Fund’ first and then focus on ploughing through these debts – starting with the highest interest rate bearing one first.

This involves lining all the debts up from highest interest rate to smallest. Then make the minimum repayments on all of them – and on the highest rated one put every single cent you can spare toward it until it is gone, before moving to the next and so on and so on.

In the meantime don’t do anything that might put your job at risk or cause you to take on more debt.

Once you have worked through all of these debts and paid them off, you can then focus back on building up the rest of your emergency fund to cover three months of your non-negotiable needs.

But, my credit cards/revolving mortgage/vintage motorbike/stamp collection are my Emergency Fund

“Uh-uh! No they’re not”!!!

During the Global Financial Crisis, specifically in America, those people who relied on their credit cards or revolving mortgages for their emergency fund suddenly found themselves broke and with no way of paying for their basic needs.

What happened was that banks needed to carry less risk and began closing down people’s line of credit with no warning.

Come pay day people would dutifully pay down their credit cards then…BAM!…money is swallowed up and credit limit reduced to the remaining balance, giving them no wiggle room to pay for anything.

The same would happen to their revolving mortgages.

If the bank felt they were carrying too much risk on a particular property then they would just swallow up the persons salaries as they were paid into their revolving credit accounts and reduce the limits – essentially leaving them with nothing. This didn’t happen here in NZ but there is no saying it can’t, and so that’s why I think it is best you keep your emergency money in cash in a separate banking institution from your mortgage.

That new TV is not an emergency

Too many people save well and deposit money into their emergency fund only to pull it out again prematurely for stupid things that do not constitute an emergency.

Replacing your TV is not an emergency, taking advantage of “once a year sale” at Briscoes is not an emergency, buying a second car or taking a supposedly well earned trip to see an 11th-cousin's wedding does not count either.

If you don’t have money to buy these things aside from your emergency fund then you can’t afford them yet.

Ways to build your Emergency fund?

Obviously the first thing that springs to mind is to save money from your pay each month. But raising money doesn’t have to just come from your income. You could try any of the following:

  • Sell stuff on Trade Me. Old clothes, books, bad Xmas presents, or projects you know you will never get around to completing.
  • Take on some extra work for a few months, such as babysitting, ironing, gardening, stacking wood – whatever you think you are capable of doing. You don’t have to do it forever – just long enough to get your fund full.
  • You could take advantage of last week's column and give away the sky TV subscription and the gym membership and save that money instead.
  • Review your insurances – there may be some savings in premiums, which you can bank instead.
  • Review your mortgage. With rates coming down, chances are you could break and re-fix your mortgage and save yourself some money in interest payments. (Watch for break-fees though).
  • Ask for a pay-rise at work. Or work extra shifts until you have saved enough.
  • Just stop buying stuff! If you have food in your belly and a place to sleep then everything else is a bonus and you don’t need to buy it until you have your emergency stash sorted.

One other thing…

You need your emergency fund to be converted to cash quickly, otherwise it’s likely next to useless.

Kids' bank accounts don’t count either.

Either you’re putting money away for your kids or you are not. (Personally we don’t do this and I’ll cover off why in another column one day). It is not your kids’ emergency – it is yours and it just doesn’t seem right to me to take from these accounts. If you need to, you should stop contributing to kids' accounts until your fund is full, and then go back to saving for them if this is an important financial goal for you.

Concluding this week…

Having an emergency fund limits the drag on your future self by being able to cope when life throws you a curve ball. My hope for you is that you will only have to save for this fund once and that ‘touch wood’ you will never have to use it.

For those who are in a relationship, having an emergency fund will positively affect the way you relate to each other – you just have to trust me on this!!!

For those of you not in a relationship – having an emergency fund makes you damn sexy!!! It says you are smart, you have security, you can set a goal and you can prioritise.